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Predicting the Equity Premium with Dividend Ratios

Yale ICF Working Paper No. 02-04

36 Pages Posted: 28 Apr 1999  

Amit Goyal

University of Lausanne; Swiss Finance Institute

Ivo Welch

University of California, Los Angeles (UCLA); National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: November 21, 2002

Abstract

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 identity—that dividend ratios have to predict long-run dividend growth or stock returns—empirically holds only over horizons longer than 5-10 years. Over shorter horizons, dividend yields primarily forecast themselves.

JEL Classification: G12, G14

Suggested Citation

Goyal, Amit and Welch, Ivo, Predicting the Equity Premium with Dividend Ratios (November 21, 2002). Yale ICF Working Paper No. 02-04. Available at SSRN: https://ssrn.com/abstract=158148 or http://dx.doi.org/10.2139/ssrn.158148

Amit Goyal

University of Lausanne ( email )

Lausanne, Vaud CH-1015
Switzerland

Swiss Finance Institute ( email )

c/o University of Geneve
40, Bd du Pont-d'Arve
1211 Geneva, CH-6900
Switzerland

Ivo Welch (Contact Author)

University of California, Los Angeles (UCLA) ( email )

110 Westwood Plaza
C519
Los Angeles, CA 90095-1481
United States
310-825-2508 (Phone)

HOME PAGE: http://www.ivo-welch.info

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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