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Demystifying India’s Equity Prices in 2016-20 using Dividend Discount Model:

Summary:
Interesting research by Priyanka Sachdeva and Abhinandan Borad in RBI’s Bulletin (Oct-2020): Financial variables, both prices as well as quantities, provide useful information in assessing economic conditions and consequently serve as important inputs for policy making. In this article, we attempt to study the movement in equity prices using a fundamental tool of valuation termed as Dividend Discount Model (DDM). The DDM framework values equities using the present discounted value approach and helps to attribute the changes in equity prices to factors including growth expectations, risk-free rate and equity risk premium (ERP). Decomposition of changes in equity prices indicate that the rise in equity prices during 2016 to early 2020 was mainly supported by decrease in interest rates

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Interesting research by Priyanka Sachdeva and Abhinandan Borad in RBI’s Bulletin (Oct-2020):

Financial variables, both prices as well as quantities, provide useful information in assessing economic conditions and consequently serve as important inputs for policy making. In this article, we attempt to study the movement in equity prices using a fundamental tool of valuation termed as Dividend Discount Model (DDM). The DDM framework values equities using the present discounted value approach and helps to attribute the changes in equity prices to factors including growth expectations, risk-free rate and equity risk premium (ERP).

Decomposition of changes in equity prices indicate that the rise in equity prices during 2016 to early 2020 was mainly supported by decrease in interest rates and ERP, with increase in forward earnings expectations contributing to a lesser extent. Thereafter, spike in ERP on COVID-19 concerns initially contributed significantly to equity prices declining sharply to compensate for increased risks. However, equity prices registered impressive recovery subsequently aided by easing of ERP.

Amol Agrawal
I am currently pursuing my PhD in economics. I have work-ex of nearly 10 years with most of those years spent figuring economic research in Mumbai’s financial sector.

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