Dividends, Momentum and Macroeconomic Variables as Determinants of the U.S. Equity Premium Across Economic Regimes

Abstract

The equity premium of the S&P 500 Index is explained in this paper by several variables that can be grouped into fundamental, behavioral and macroeconomic factors. We hypothesize that the statistical significance of these variables changes across economic regimes. The three regimes we consider are the low, medium and high volatility regimes in contrast to previous studies that do not differentiate across economic regimes. Using the three-state Markov switching regime econometric methodology we confirm that the statistical significance of the independent variables representing fundamentals, macroeconomic conditions and a behavioral variable changes across economic regimes. Our findings offer an improved understanding of what moves the equity premium across economic regimes than what we can learn from single-equation estimation. Our results also confirm the significance of momentum as a behavioral variable across all economic regimes.

Keywords: Excess stock returns, equity premium, dividends, macroeconomic variables, momentum, Markov regimes

JEL Classification: C22, E44, G12