Accounting-Based Valuation with Changing Interest Rates

Review of Accounting Studies · 2004 · Volume 9 · Issue 4

Abstract

This paper generalizes Ohlson’s [Contemporary Accounting ResearchVol. 11 No. 2. 661–687 (1995)] equity valuation framework to allow for stochastic interest rates. Much of this analysis initially deals with the specialized setting in which earnings suffice for cum-dividend value. In such a case, the beginning-of-period (lagged) rate determines the capitalization factor, not the current rate. The underlying earnings dynamic modifies the traditional random walk model via an additional term, namely current earnings multiplied by the percentage change in interest rates. The general model retains these basic aspects of the earnings-sufficiency setting. Empirical implications bear on the returns-to-earnings regression: The earnings-response coefficient decreases as the beginning-of-period rate increases.

Keywords

stochastic interest rates, valuation, Ohlson model, random walk model of earnings, permanent earnings, earnings response coefficient

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