Expected Returns and Dividend Growth Rates Implied by Derivative Markets
Review of Financial Studies, 2014 (27), 790-822
68 Pages Posted: 23 Sep 2008 Last revised: 7 Dec 2015
Date Written: November 19, 2013
The dividend-price ratio is a noisy proxy for expected returns when expected dividend growth is time-varying. This paper uses a new and forward-looking measure of dividend growth extracted from S&P 500 futures and options to correct the dividend-price ratio for changes in expected dividend growth. Over January 1994 through June 2011, dividend growth implied by derivative markets reliably forecast future dividend growth, and the corrected dividend-price ratio predicts S&P 500 returns substantially better than the standard dividend-price ratio, in-sample and out-of-sample. Time-varying expected dividend growth is important to explain price movements, especially because it is highly correlated with expected returns.
Keywords: present value models, dividend-price ratio, return predictability, derivatives
JEL Classification: G12, G13
Suggested Citation: Suggested Citation