The Dividend-Price Ratio Does Predict Dividend Growth: International Evidence

43 Pages Posted: 13 Aug 2009 Last revised: 28 Feb 2013

See all articles by Tom Engsted

Tom Engsted

University of Aarhus - CREATES

Thomas Quistgaard Pedersen

Aarhus University - CREATES

Date Written: January 1, 2010

Abstract

Unpredictable dividend growth by the dividend-price ratio is considered a 'stylized fact' in post war US data. Using long-term annual data from the US and three European countries, we revisit this stylized fact, and we also report results on return predictability. We make two main contributions. First, we document that for the US, results for long-horizon predictability are crucially dependent on whether returns and dividend growth are measured in nominal or real terms, and this difference is due to long-term inflation being strongly negatively predictable by the dividend-price ratio. The impact of inflation is to reinforce real return predictability and to reduce - or change direction of - real dividend growth predictability. This provides an explanation for the strong predictability of long-horizon real returns in the 'right' direction, and the strong predictability of long-horizon real dividend growth in the 'wrong' direction, that we see in US post war data. Second, we find that predictability patterns in three European stock markets are in many ways different from what characterize the US stock market. In particular, in Sweden and Denmark dividend growth is strongly predictable by the dividend-price ratio in the 'right' direction while returns are not predictable. The results for the UK are mixed. Our results are robust to a number of changes in the modeling framework. We discuss the results for dividend growth predictability in terms of the 'dividend smoothing hypothesis'.

Keywords: dividend-price ratio, equity return and dividend growth, short- and long-horizon predictability, dividend smoothing, VAR model, asymptotic and small-sample tests

JEL Classification: G12, E44

Suggested Citation

Engsted, Tom and Pedersen, Thomas Quistgaard, The Dividend-Price Ratio Does Predict Dividend Growth: International Evidence (January 1, 2010). Journal of Empirical Finance, Vol. 17, No. 4, 2010. Available at SSRN: https://ssrn.com/abstract=1447372

Tom Engsted (Contact Author)

University of Aarhus - CREATES ( email )

School of Economics and Management
Building 1322, Bartholins Alle 10
DK-8000 Aarhus C
Denmark

Thomas Quistgaard Pedersen

Aarhus University - CREATES ( email )

School of Economics and Management
Building 1322, Bartholins Alle 10
DK-8000 Aarhus C
Denmark

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