The Predictability of Returns with Regime Shifts in Consumption and Dividend Growth

39 Pages Posted: 16 Mar 2010

See all articles by Anisha Ghosh

Anisha Ghosh

Carnegie Mellon University

George M. Constantinides

University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER)

Multiple version iconThere are 4 versions of this paper

Date Written: January 10, 2010

Abstract

The puzzle that the market-wide price-dividend ratio predicts neither the market return nor dividend growth in linear regressions is addressed in an equilibrium model with two regimes where the process of the conditional mean of dividend growth is more predictable in one regime than in the other. The consumer observes x_t that is approximately the conditional mean of the aggregate consumption growth rate and also calculates the posterior probability, p_t, that the economy is in the first regime. In linear predictive regressions over 1930-2006, the price-dividend ratio predicts the market return but not dividend growth if p_t > 0.5; and it predicts dividend growth but not the market return if p_t < 0.5. Furthermore, in linear predictive regressions, the state variables (x_t, p_t) and their product perform significantly better at predicting the equity premium, size premium, value premium, consumption growth, and dividend growth over 1930-2006, than linear regressions with predictive variables the price-dividend ratio and risk free rate.

Keywords: Return Predictability, Consumption Growth Predictability, Dividend Growth Predictability, Regime Shifts, Cross-Section of Returns

JEL Classification: G12, E44

Suggested Citation

Ghosh, Anisha and Constantinides, George M., The Predictability of Returns with Regime Shifts in Consumption and Dividend Growth (January 10, 2010). Available at SSRN: https://ssrn.com/abstract=1570653 or http://dx.doi.org/10.2139/ssrn.1570653

Anisha Ghosh (Contact Author)

Carnegie Mellon University ( email )

5000 Forbes Avenue
Pittsburgh, PA 15213-3890
United States

George M. Constantinides

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
773-702-7258 (Phone)
773-752-0458 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
78
Abstract Views
865
rank
78,126
PlumX Metrics