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The St. Petersburg paradox and capital asset pricing

Author

Listed:
  • Assaf Eisdorfer

    (University of Connecticut)

  • Carmelo Giaccotto

    (University of Connecticut)

Abstract

Durand (J Finance 12:348–363, 1957) shows that the classical St. Petersburg paradox can apply to the valuation of a firm whose dividends grow at a constant rate forever. To capture a more realistic pattern of dividends, we model the dividend growth rate as a mean reverting process, and then use the capital asset pricing model to derive the risk-adjusted present value. The model generates an equivalent St. Petersburg game. The long-run growth rate of the payoffs (dividends) is dominant in driving the value of the game (firm), and the condition under which the value is finite is less restrictive than that of the standard game.

Suggested Citation

  • Assaf Eisdorfer & Carmelo Giaccotto, 2016. "The St. Petersburg paradox and capital asset pricing," Annals of Finance, Springer, vol. 12(1), pages 1-16, February.
    • Handle: RePEc:kap:annfin:v:12:y:2016:i:1:d:10.1007_s10436-015-0269-x
    DOI: 10.1007/s10436-015-0269-x
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    References listed on IDEAS

    as
    1. David Durand, 1957. "Growth Stocks And The Petersburg Paradox," Journal of Finance, American Finance Association, vol. 12(3), pages 348-363, September.
    2. Fama, Eugene F., 1977. "Risk-adjusted discount rates and capital budgeting under uncertainty," Journal of Financial Economics, Elsevier, vol. 5(1), pages 3-24, August.
    3. Ľuboš Pástor & Veronesi Pietro, 2003. "Stock Valuation and Learning about Profitability," Journal of Finance, American Finance Association, vol. 58(5), pages 1749-1789, October.
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    5. William F. Sharpe, 1964. "Capital Asset Prices: A Theory Of Market Equilibrium Under Conditions Of Risk," Journal of Finance, American Finance Association, vol. 19(3), pages 425-442, September.
    6. Fama, Eugene F & French, Kenneth R, 2000. "Forecasting Profitability and Earnings," The Journal of Business, University of Chicago Press, vol. 73(2), pages 161-175, April.
    7. repec:bla:jfinan:v:58:y:2003:i:5:p:1749-1790 is not listed on IDEAS
    8. Szekely, Gabor J. & Richards, Donald S.t.P., 2004. "The St. Petersburg Paradox and the Crash of High-Tech Stocks in 2000," The American Statistician, American Statistical Association, vol. 58, pages 225-231, August.
    9. Milton Friedman & L. J. Savage, 1948. "The Utility Analysis of Choices Involving Risk," Journal of Political Economy, University of Chicago Press, vol. 56(4), pages 279-279.
    10. Harjoat S. Bhamra & Lars-Alexander Kuehn & Ilya A. Strebulaev, 2010. "The Levered Equity Risk Premium and Credit Spreads: A Unified Framework," The Review of Financial Studies, Society for Financial Studies, vol. 23(2), pages 645-703, February.
    11. Mark Rubinstein, 1976. "The Valuation of Uncertain Income Streams and the Pricing of Options," Bell Journal of Economics, The RAND Corporation, vol. 7(2), pages 407-425, Autumn.
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    Cited by:

    1. Ruggero Paladini, 2017. "Il paradosso di S. Pietroburgo, una rassegna," Public Finance Research Papers 29, Istituto di Economia e Finanza, DSGE, Sapienza University of Rome.

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    More about this item

    Keywords

    Capital asset pricing model (CAPM); Stochastic dividends; Equity valuation; Dividend discount model; St. Petersburg paradox;
    All these keywords.

    JEL classification:

    • G0 - Financial Economics - - General
    • G1 - Financial Economics - - General Financial Markets

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