Predicting the Equity Premium with Dividend Ratios
University of Lausanne; Swiss Finance Institute
University of California, Los Angeles (UCLA); National Bureau of Economic Research (NBER)
November 21, 2002
Yale ICF Working Paper No. 02-04
Our paper suggests a simple recursive residuals (out-of-sample) graphical approach to evaluating the predictive power of popular equity premium and stock market time-series forecasting regressions. When applied, we find that dividend-ratios should have been known to have no predictive ability even prior to the 1990s, and that any seeming ability even then was driven by only two years, 1973 and 1974. Our paper also documents changes in the time-series processes of the dividends themselves and shows that an increasing persis-tence of dividend-price ratio is largely responsible for the inability of dividend ratios to predict equity premia. Cochrane (1997)'s accounting identitythat dividend ratios have to predict long-run dividend growth or stock returnsempirically holds only over horizons longer than 5-10 years. Over shorter horizons, dividend yields primarily forecast themselves.
Number of Pages in PDF File: 36
JEL Classification: G12, G14working papers series
Date posted: April 28, 1999
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