Back-Tests of the Dividend Discount Model Using Time-Varying Cost of Equity

20 Pages Posted: 16 Sep 2016

See all articles by Ping McLemore

Ping McLemore

Federal Reserve Banks - Quantitative Supervision & Research

George Woodward

University of Colorado, Colorado Springs

Thomas Zwirlein

University of Colorado, Colorado Springs

Date Written: September 14, 2016

Abstract

This paper examines prediction errors in the general dividend discount model using a back-test method. The prediction errors are based on realized dividends, terminal stock prices, and estimates of time-varying discount rates. Models of varying lengths are examined in our tests. We include firms with a continuous record of dividend payments over the 20 years in our sample. We find that prediction errors vary from a high of approximately 55% to a low of 2% depending on the length of period used to calculate the estimated model. Reducing the number of dividends and the horizon date in the model reduces prediction error. Prediction error is also reduced by using time-varying equity discount rates when market volatility increases.

Suggested Citation

McLemore, Ping and Woodward, George and Zwirlein, Thomas, Back-Tests of the Dividend Discount Model Using Time-Varying Cost of Equity (September 14, 2016). Journal of Applied Finance (Formerly Financial Practice and Education), Vol. 25, No. 2, 2015, Available at SSRN: https://ssrn.com/abstract=2838993

Ping McLemore

Federal Reserve Banks - Quantitative Supervision & Research ( email )

United States

George Woodward

University of Colorado, Colorado Springs ( email )

1420 Austin Bluffs Parkway
Colorado Springs, CO 80918-7150
United States

Thomas Zwirlein (Contact Author)

University of Colorado, Colorado Springs ( email )

1420 Austin Bluffs Parkway
Colorado Springs, CO 80918-7150
United States

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
341
Abstract Views
2,450
Rank
161,360
PlumX Metrics