Rediscover Predictability: Information from the Relative Prices of Long-Term and Short-Term Dividends
Charles A. Dice Center Working Paper No. 2018-16
62 Pages Posted: 14 Feb 2018 Last revised: 3 Oct 2018
Date Written: September 30, 2018
The ratio of long- to short-term dividend prices, "price ratio" (pr), predicts one-year stock market return with an out-of-sample R2 of 19%. It subsumes the predictive power of price-to-dividend ratio (pd). The residual from regressing pd on pr predictsone-year dividend with an out-of-sample R2 of 30%. Our results hold outside the U.S. In an exponential-affine model, we show the key to understand these findings is the (lack of) persistence of expected dividend growth. We also characterize the risk of time-varying expected return: (1) the expected return is countercyclical; (2) the response of expected return (rather than expected dividend growth) accounts for the impact of monetary policy on stock price; (3) shocks to pr are priced in the cross-section, which serves as an ICAPM test of pr as an adequate proxy for the expected return.
Keywords: return predictability, cash flow predictability, dividend strip price, ICAPM, time-varying expected return
JEL Classification: G12
Suggested Citation: Suggested Citation