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

42 Pages Posted: 6 Jul 2010 Last revised: 6 Sep 2012

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)

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Date Written: July 4, 2010

Abstract

The predictability of the market return and dividend growth is addressed in an equilibrium model with two regimes. A state variable that drives the conditional means of the aggregate consumption and dividend growth rates follows different time-series processes in the two regimes. In linear predictive regressions over 1930-2009, the market return is predictable by the price-dividend ratio with R2 11.7% if the probability of being in the first regime exceeds 50%; and dividend growth is predictable by the price-dividend ratio with R2 28.3% if the probability of being in the second regime exceeds 50%. The model-implied state variables perform significantly better at predicting the equity, size, and value premia, the aggregate consumption and dividend growth rates, and the variance of market return than linear regressions with the market price-dividend ratio and risk free rate as predictive variables.

Keywords: Return Predictability, Consumption Growth Predictability, Dividend Growth Predictability, Regime Shifts, Cross-Section of Returns, Equity Premium, Size Premium, Value Premium

JEL Classification: G12, E44

Suggested Citation

Ghosh, Anisha and Constantinides, George M., The Predictability of Returns with Regime Shifts in Consumption and Dividend Growth (July 4, 2010). CRSP Working Paper Forthcoming, Available at SSRN: https://ssrn.com/abstract=1634984

Anisha Ghosh

Carnegie Mellon University ( email )

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George M. Constantinides (Contact Author)

University of Chicago - Booth School of Business ( email )

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National Bureau of Economic Research (NBER)

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