Dividend Yields are Equity Risk Premiums
8 Pages Posted: 19 Oct 2005
This article presents evidence that dividend yields are directly related to and predict future stock returns: The higher the yield, the higher the stock return. The paper uses the constant dividend growth model and the subsidiary Golden Rule of Accumulation view that real long-term growth equals the real rate of interest in order to show that the dividend yield is directly related to the risk premium. A predictive test shows that dividend yields provide superior predictions of equity risk premiums in terms of lower bias, lower mean square error and lower mean absolute error as compared with the method of using historical realized returns.
Keywords: dividend yield, stock returns, constant growth model, risk premium
JEL Classification: G11, G12, G14
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