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

67 Pages Posted: 14 Feb 2018 Last revised: 1 Aug 2018

Ye Li

Ohio State University

Chen Wang

Yale School of Management

Date Written: June 4, 2018

Abstract

The prices of dividends at alternative horizons contain critical information on the behavior of aggregate stock market. The ratio between prices of long- and short-term dividends, “price ratio" (pr), predicts annual market return with an out-of-sample R2 of 19%. pr subsumes the predictive power of traditional price-dividend ratio (pd). After orthogonalized to pr, the residuals of pd strongly predict dividend growth. Using an exponential-affine model, we show a one-to-one mapping between pr and the expected market return when the expectation of future cash flow is transient. Moreover, we find that return predictability is stronger after market downturns, and holds outside the U.S. As an economic test, shocks to pr are priced in the cross-section of stocks, consistent with ICAPM. Our measure of expected return declines during monetary expansions, and varies strongly with the conditions of macroeconomy, financial intermediaries, and sentiment.

Keywords: return predictability, transient cash flow expectation, short-term dividend price

JEL Classification: G12

Suggested Citation

Li, Ye and Wang, Chen, Rediscover Predictability: Information from the Relative Prices of Long-Term and Short-Term Dividends (June 4, 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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