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

The ratio of long- to short-term dividend prices, “price ratio” (pr), predicts annual market return with an out-of-sample R2 of 19%, subsuming the predictive power of price-dividend ratio (pd). After controlling for pr, pd predicts dividend growth with an out-of-sample R2 of 30%. Our results hold outside the U.S. An exponential-affine model shows that the key to our findings is the (lack of) persistence of expected dividend growth. We find the expected return is countercyclical and responds strongly to monetary policy shocks. As implied by ICAPM, shocks to pr, the expected-return proxy, are priced in the cross section.

Keywords: return predictability, cash flow predictability, dividend strip price, ICAPM, time-varying expected return

JEL Classification: G12

Suggested Citation: Suggested Citation

Li, Ye and Wang, Chen, Rediscover Predictability: Information from the Relative Prices of Long-Term and Short-Term Dividends (October 16, 2018). Fisher College of Business Working Paper No. 2018-03-016, Charles A. Dice Center Working Paper No. 2018-16, Paris December 2018 Finance Meeting EUROFIDAI - AFFI, Available at SSRN: https://ssrn.com/abstract=3116437 or http://dx.doi.org/10.2139/ssrn.3116437