The Dividend Disconnect

Abstract

Many individual investors, mutual funds and institutions trade as if dividends and capital gains are disconnected attributes, not fully appreciating that dividends result in price decreases. Behavioral trading patterns (e.g. the disposition effect) are driven by price changes instead of total returns. Investors rarely reinvest dividends, and trade as if they are a separate, stable income stream. Analysts fail to account for the effect of dividends on price, leading to optimistic price forecasts for dividend-paying stocks. Demand for dividends is systematically higher in periods of low interest rates and poor market performance, leading to lower returns for dividend-paying stocks.

Keywords: Behavioral Finance, Dividends, Mental Accounting, Asset Pricing

JEL Classification: G02, G11, G12, D14