A new approach to estimating value–income ratios with income growth and time-varying yields

•The paper proposes a new type of present value model with income growth and time-varying yields.•The value–income ratio should be adjusted by yields of the asset and growth in income.•The use of a simple price–dividend ratio in assessing market behavior should be avoided in practice.

Value–income ratios, such as dividend yields in finance and price–rent ratios in housing and real estate markets, impact society in a variety of ways. This paper proposes a new type of the present value model that features income growth with time-varying yields. It offers a new risk perspective, which may alleviate timid investor behavior in market downturns while cooling down the market in seemingly booming times. A binding relationship, the value–income ratio adjusted by yields of the asset and growth in income, is revealed. This has notable implications for empirical research, which examines value–income ratios time and again. Incorrectly perceived market behavior distorts the formation of investor behavior, and vice versa, which has serious consequences to the functioning of the market and beyond.