Understanding Predictability

Posted: 26 Jan 2004

See all articles by Lior Menzly

Lior Menzly

University of Chicago - Booth School of Business

Pietro Veronesi

University of Chicago - Booth School of Business; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Tano Santos

Columbia Business School; National Bureau of Economic Research (NBER)

Abstract

We propose a general equilibrium model with multiple securities in which investors' risk preferences and expectations of dividend growth are time-varying. While time-varying risk preferences induce the standard positive relation between the dividend yield and expected returns, time-varying expected dividend growth induces a negative relation between them. These offsetting effects reduce the ability of the dividend yield to forecast returns and eliminate its ability to forecast dividend growth, as observed in the data. The model links the predictability of returns to that of dividend growth, suggesting specific changes to standard linear predictive regressions for both. The model's predictions are confirmed empirically.

Suggested Citation

Menzly, Lior and Veronesi, Pietro and Santos, Tano, Understanding Predictability. Available at SSRN: https://ssrn.com/abstract=489624

Lior Menzly

University of Chicago - Booth School of Business ( email )

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Pietro Veronesi (Contact Author)

University of Chicago - Booth School of Business ( email )

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Centre for Economic Policy Research (CEPR)

London
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National Bureau of Economic Research (NBER)

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Tano Santos

Columbia Business School ( email )

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New York, NY 10027
United States
212-854-0489 (Phone)
212-316-9180 (Fax)

National Bureau of Economic Research (NBER)

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United States

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