A review of the dividend discount model: From deterministic to stochastic models

This chapter introduces a comprehensive overview of the dividend discount models, with a focus on the modeling of the dividend growth process. It starts with an introduction to the basic valuation model with some general aspects to consider when performing the computation. The chapter presents the Gordon growth model that represents the cornerstone of the stock valuation. It discusses some extensions, mainly based on the modeling of the dividend process, starting from the two-stage model up to the geometric or arbitrary dividend growth model. The chapter provides a discussion on more recent advancements in which the dividend process is modeled as a Markov chain. The idea of the Markov chain stock models is to describe the dividend growth rate as a sequence of independent, identically distributed discrete random variables, and to model it as a Markov process. The chapter also analyzes the problem of valuating multiple stocks when they constitute a financial portfolio.