Returns adjusted for dividends

Question

In various financial models such as CAPM, Black Scholes, one assumes the returns are adjusted for dividends.

As I understand it, the share price often (in a relative sense) increases a bit before the dividend is paid, and decreases a bit once the dividend has been paid. This intuitive so you cannot make a significant profit by buying and selling before and after the dividend is paid. Please correct me it I'm wrong however.

In light if this, what is the agreed upon way(s) for adjusting share prices for dividends? Yahoo finance report "adjusted" share prices for example -- how do they calculate them?

Answer 1

I am assuming that you are interested in how the returns behave around dividend payment dates, since the adjustment process for Yahoo is covered in their help section. The drop has been found to be aprox. the amount of the dividend yield. More recently it appears, that in the run-up to the dividend date some premium may be earned.