Testing Return Predictability with the Dividend-Growth Equation: An Anatomy of the Dog

26 Pages Posted: 19 Jun 2019 Last revised: 28 Jun 2019

See all articles by Erik Hjalmarsson

Erik Hjalmarsson

University of Gothenburg - Centre for Finance

Tamás Kiss

Örebro University - School of Business

Date Written: April 8, 2019

Abstract

The dividend-growth based test of return predictability, proposed by Cochrane [2008, Review of Financial Studies 21, 1533-1575], is similar to a likelihood-based test of the standard return-predictability model, treating the autoregressive parameter of the dividend-price ratio as known. In comparison to standard OLS-based inference, both tests achieve power gains from a strong use of the exact value postulated for the autoregressive parameter. When compared to the likelihood-based test, there are no power advantages for the dividend-growth based test. In common implementations, with the autoregressive parameter set equal to the corresponding OLS estimate, Cochrane's test also suffers from severe size distortions.

Keywords: Predictive regressions, Present-value relationship, Stock-return predictability

JEL Classification: C22, G1

Suggested Citation

Hjalmarsson, Erik and Kiss, Tamás, Testing Return Predictability with the Dividend-Growth Equation: An Anatomy of the Dog (April 8, 2019). Available at SSRN: https://ssrn.com/abstract=3402409 or http://dx.doi.org/10.2139/ssrn.3402409

Erik Hjalmarsson (Contact Author)

University of Gothenburg - Centre for Finance ( email )

Box 640
Gothenburg, 403 50
Sweden

Tamás Kiss

Örebro University - School of Business

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