Consider the constant-growth dividend discount model, where pt= Dt 1+g/k-g, where pt and Dt are prices and dividends in period t, and k is the rate of return on equity, g is the growth rate of dividends, and k > g. Then pt/Dt= 1+g/k-g. Provide an economic explanation for the effect of a fall in k on the price-dividend ratio.
(a) If we observe a rise in the ratio of pt/ dt relative to its historic average, how might this be explained within the context of the model?
(b) How do these explanations relate to the "this time is different" thesis? Explain.
(c) Can you relate your explanation to any historic examples of bubbles?