Dividend Yield, Risk, and Mispricing: A Bayesian Analysis
London Business School Accounting Subject Area Working Paper
55 Pages Posted: 20 May 2004
Date Written: May 6, 2004
We extend Kandel and Stambaugh's (1996) work on return predictability and dividend yield to accommodate time-variation in market risk as well as expected return. Variation in risk is statistically and economically important, but most of the yield related return predictability is unrelated to risk. Differences in prior beliefs about the extent to which predictability is due to risk or mispricing can have economically significant effects on asset allocation between the market and a riskless asset. Beliefs about the risk-return tradeoff can also be important, with Merton's (1980) theoretical proportionality condition employed as a prior reference point.
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