Valuation, Linear Information Dynamic, and Stochastic Discount Rates

Abstract

We generalize Ohlson (1995) to stochastic interest rates. Our analysis provides four insights. First, the earnings capitalization multiple depends on the lagged rate, not the current rate. Second, the abnormal earnings persistence parameter increases in the current rate and decreases in the lagged rate. Third, it is not necessary to specify the stochastic process underlying interest rates to relate stock prices and accounting numbers. Finally, only the lagged rate is needed to capitalize current earnings to determine current stock price, while both the lagged and current rates are needed to forecast next-period earnings based on current earnings.