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Revisiting dividend yield dynamics and returns predictability: Evidence from a time-varying ESTR model

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  • McMillan, David G.
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    Abstract

    Since the bubble of the late 1990s the dividend yield appears non-stationary indicating the breakdown of the equilibrium relationship between prices and dividends. Two lines of research have developed in order to explain this apparent breakdown. First, that the dividend yield is better characterised as a non-linear process and second, that it is subject to mean level shifts. This paper jointly models both of these characteristics by allowing non-linear reversion to a changing mean level. Results support stationarity of this model for eight international dividend yield series. This model is than applied to the forecast of monthly stock returns. Evidence supports our time-varying non-linear model over linear alternatives, particularly so on the basis of an out-of-sample R-squared measure and a trading rule exercise. More detailed examination of the trading rule measure suggests that investors could obtain positive returns, as the model forecasts do not imply excessive trading such that costs would not outweigh returns. Finally, the superior performance of the non-linear model largely arises from its ability to forecast negative returns, whereas linear models are unable to do.

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    Bibliographic Info

    Article provided by Elsevier in its journal The Quarterly Review of Economics and Finance.

    Volume (Year): 49 (2009)
    Issue (Month): 3 (August)
    Pages: 870-883

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    Handle: RePEc:eee:quaeco:v:49:y:2009:i:3:p:870-883

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    Web page: http://www.elsevier.com/locate/inca/620167

    Related research

    Keywords: Dividend yield Returns predictability Forecasting Time-varying ESTR model;

    References

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    Cited by:
    1. Vicente Esteve & Manuel Navarro-Ibáñez & María A. Prats, 2013. "The present value model of U.S. stock prices revisited: long-run evidence with structural breaks, 1871-2010," Working Papers 13-04, Asociación Española de Economía y Finanzas Internacionales.
    2. Adelina Gschwandtner & Michael Hauser, 2013. "Profit Persistence and Stock Returns," Studies in Economics 1320, Department of Economics, University of Kent.

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