Endogenous Dividend Dynamics and the Term Structure of Dividend Strips

Abstract

Many leading asset pricing models predict that the term structure of expected returns and volatilities on dividend strips are upward sloping. Yet the empirical evidence suggests otherwise. This discrepancy can be reconciled if EBIT dynamics are combined with a dynamic capital structure strategy that generates stationary leverage ratios. This combination endogenously determines dividend dynamics that are cointegrated with EBIT, implying that long-horizon dividend strips are no riskier than long-horizon EBIT strips. This capital structure policy also implies that shareholders have their position 'managed', creating stock volatility that is higher than long-horizon dividend volatility (i.e., excess volatility).