Rediscover Predictability: Information from the Relative Prices of Long-Term and Short-Term Dividends

Fisher College of Business Working Paper No. 2018-03-016

Charles A. Dice Center Working Paper No. 2018-16

62 Pages Posted: 14 Feb 2018 Last revised: 3 Oct 2018

Ye Li

Ohio State University

Chen Wang

Yale School of Management

Date Written: September 30, 2018

Abstract

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

Li, Ye and Wang, Chen, Rediscover Predictability: Information from the Relative Prices of Long-Term and Short-Term Dividends (September 30, 2018). Fisher College of Business Working Paper No. 2018-03-016. Available at SSRN: https://ssrn.com/abstract=3116437 or http://dx.doi.org/10.2139/ssrn.3116437

Ye Li

Ohio State University ( email )

Fisher Hall 836, 2100 Neil Ave
Columbus, OH 43210
United States

HOME PAGE: http://yeli-macrofinance.com

Chen Wang (Contact Author)

Yale School of Management ( email )

135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States

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