Statistical Methods in Finance 2016

Dec 18 - 22, 2016


An inquiry into the equilibrium relation between equity prices, dividends and gilt yields in India

by Pranab Kumar Das

The goal of the paper is to analyze the nature of contemporaneous equilibrium relation between equity prices, dividend yields and gilt returns in India from the mid 1990s to date. PV model of equity price determination a la Gordon establishes a relation between equity prices, dividends and interest rate. This has been discussed in the academic finance literature as gilt-equity yield ratio (GEYRY) in the form of a stable relationship. The relationship between equity and gilts has also been formulated in a macro-theroretic/ general equilibrium structureby James Tobin and his co-authors where all financial assets are substitutes. The concept has, however, been receiving attention from the portfolio managers such as Barclays, particularly in UK since 1950s to predict equity returns. In more recent times it is being investigated in the cointegration for the long run relationship and VECM framework for short run dynamics in the finance literature. As a matter of fact FED and SVM models of equity prices in US are some variant of the same idea. The present study first attempts to find a long run equilibrium relationship for India in the integrated time series tradition. Identification of the VAR model is sought on the basis of economic theory. The resultant structural VAR (SVAR) model is then employed to inquire the dynamics of the interactions of the three variables. The empirical study has several policy implications for the macro economy.