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Demographics and fluctuations in Dividend/Price

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  • Andrea Tamoni
  • Arie E.Gozluklu
  • Carlo A.Favero

Abstract

The dynamic dividend growth model (Campbell&Shiller, 1988) linking the log dividend yield to future expected dividend growth and stock market returns has been extensively used in the literature for forecasting stock returns. The empirical evidence on the performance of the model is mixed as its strength varies with the sample choice. This model is derived on the assumption of stationary dpt, dividend-yield. The empirical validity of such hypothesis has been challenged in recent literature (Lettau&Van Nieuwerburgh, 2007) with strong evidence on a time varying mean, due to breaks, in this financial ratio. In this paper, we show that the slowly evolving mean toward which the dividend price ratio is reverting is determined by demographic factors. We also show that a forecasting model based on demographics and a demand factor as captured by excess consumption in the sense of Lettau and Ludvigson(2004) overperforms virtually all alternative models proposed in the empirical literature in the framework of the dynamic dividend growth model. Finally, we exploit the predictability of demographic factors to project the equity risk premium up to 2050.

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Bibliographic Info

Paper provided by IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University in its series Working Papers with number 345.

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Date of creation: 2008
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Handle: RePEc:igi:igierp:345

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  1. Ivo Welch & Amit Goyal, 2008. "A Comprehensive Look at The Empirical Performance of Equity Premium Prediction," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 21(4), pages 1455-1508, July.
  2. Ang, Andrew & Maddaloni, Angela, 2003. "Do demographic changes affect risk premiums? Evidence from international data," Working Paper Series, European Central Bank 0208, European Central Bank.
  3. John Y. Campbell & Robert J. Shiller, 1988. "Stock Prices, Earnings and Expected Dividends," Cowles Foundation Discussion Papers, Cowles Foundation for Research in Economics, Yale University 858, Cowles Foundation for Research in Economics, Yale University.
  4. Stefano DellaVigna & Joshua M. Pollet, 2007. "Demographics and Industry Returns," American Economic Review, American Economic Association, American Economic Association, vol. 97(5), pages 1667-1702, December.
  5. Lewellen, Jonathan, 2004. "Predicting returns with financial ratios," Journal of Financial Economics, Elsevier, Elsevier, vol. 74(2), pages 209-235, November.
  6. Kydland, Finn E & Prescott, Edward C, 1982. "Time to Build and Aggregate Fluctuations," Econometrica, Econometric Society, Econometric Society, vol. 50(6), pages 1345-70, November.
  7. Martin Lettau & Sydney Ludvigson, 2003. "Understanding Trend and Cycle in Asset Values: Reevaluating the Wealth Effect on Consumption," NBER Working Papers 9848, National Bureau of Economic Research, Inc.
  8. Shmuel Kandel & Robert F. Stambaugh, . "Modeling Expected Stock Returns for Long and Short Horizons," Rodney L. White Center for Financial Research Working Papers, Wharton School Rodney L. White Center for Financial Research 42-88, Wharton School Rodney L. White Center for Financial Research.
  9. Johansen, Soren, 1988. "Statistical analysis of cointegration vectors," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 12(2-3), pages 231-254.
  10. Owen Lamont, 1998. "Earnings and Expected Returns," Journal of Finance, American Finance Association, American Finance Association, vol. 53(5), pages 1563-1587, October.
  11. Martin Lettau & Stijn Van Nieuwerburgh, 2006. "Reconciling the Return Predictability Evidence," 2006 Meeting Papers, Society for Economic Dynamics 29, Society for Economic Dynamics.
  12. Andrew B. Abel, 2002. "The effects of a baby boom on stock prices and capital accumulation in the presence of Social Security," Working Papers 03-2, Federal Reserve Bank of Philadelphia.
  13. Martin Lettau & Sydney Ludvigson, 2003. "Expected Returns and Expected Dividend Growth," NBER Working Papers 9605, National Bureau of Economic Research, Inc.
  14. Juselius, Katarina, 2006. "The Cointegrated VAR Model: Methodology and Applications," OUP Catalogue, Oxford University Press, Oxford University Press, number 9780199285679, October.
  15. Andrew Ang & Geert Bekaert, 2001. "Stock Return Predictability: Is it There?," NBER Working Papers 8207, National Bureau of Economic Research, Inc.
  16. Johansen, Soren, 1991. "Estimation and Hypothesis Testing of Cointegration Vectors in Gaussian Vector Autoregressive Models," Econometrica, Econometric Society, Econometric Society, vol. 59(6), pages 1551-80, November.
  17. Goyal, Amit, 2004. "Demographics, Stock Market Flows, and Stock Returns," Journal of Financial and Quantitative Analysis, Cambridge University Press, Cambridge University Press, vol. 39(01), pages 115-142, March.
  18. Bakshi, Gurdip S & Chen, Zhiwu, 1994. "Baby Boom, Population Aging, and Capital Markets," The Journal of Business, University of Chicago Press, University of Chicago Press, vol. 67(2), pages 165-202, April.
  19. Henrik Hansen & Søren Johansen, 1999. "Some tests for parameter constancy in cointegrated VAR-models," Econometrics Journal, Royal Economic Society, Royal Economic Society, vol. 2(2), pages 306-333.
  20. Lettau, Martin & Ludvigson, Sydney, 1999. "Consumption, Aggregate Wealth and Expected Stock Returns," CEPR Discussion Papers, C.E.P.R. Discussion Papers 2223, C.E.P.R. Discussion Papers.
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