Deriving the Dividend Discount Model from an Asset Pricing Equation

Summary

The document asks how to derive the dividend discount model from an asset pricing equation discussed in Eugene Fama’s review of efficient capital markets. It describes splitting today’s asset price into a discounted expectation of a future price, with an information term that represents market information about price and risk. For a share, the author proposes expressing future price through dividends and asks whether that substitution is valid.

The text gives no equations beyond describing the proposed steps, and it includes no derivation or answer. A key issue left unresolved is how the pricing relation’s expectations, discounting, and information or risk adjustment apply across future dividends and terminal value. The note is therefore a conceptual question rather than a complete valuation method, and it does not establish conditions under which the proposed transformation holds.

Key ideas

• The author seeks to connect an asset pricing equation to the dividend discount model.
• The proposed approach expresses today’s price as a discounted function of a future price.
• For shares, the author suggests representing future price through dividends.
• The document does not provide enough algebra or assumptions to verify the derivation.

Tags

# Asset pricing and dividend discount model


# Asset pricing and dividend discount model












I want to derive the dividend discount model from the asset pricing formula described in "Efficient Capital Markets: A Review of Theory and Empirical Work" by Eugene Fama 1970. The formula that I am referring to is equation number 1:

What I could do so far is the following:

As you can see I separated the asset price today as a function of future price discounted. The phi represents the information in the market about the price, risk etc. If we are pricing a share, we can consider the future price the sum of all the discounted dividends to today, therefore we can rewrite to the following:

Is this correct? If extra information is needed I will provide. Thank you!

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