EC223 Lecture Notes - Lecture 13: Arbitrage, Adaptive Expectations, Dividend Discount Model
Document Summary
D0=the most recent dividend paid g=the expected constant growth rate in dividends ke=the required return on an investment in equity. Dividends are assumed to continue growing at a constant rate forever. The growth rate is assumed to be less than the required return on equity. Price is set by the buyer with highest willingness to pay. Typically the buyer who can take best advantage of the asset. Superior information about an asset can increase its value by reducing its perceived risk. When new information is released about a firm, expectations and prices change. Market participants constantly receive information and revise their expectations, so stock prices change frequently. Application: the global financial crisis and the stock market. Financial crisis that started in august 2007 led to one of. Financial crisis that started in august 2007 led to one of the worst bear markets in 50 years. Gordon model predicts a drop in stock prices.
