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Predicting the equity premium with dividend ratios: Reconciling the evidence

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  • Kellard, Neil M.
  • Nankervis, John C.
  • Papadimitriou, Fotios I.

Abstract

This paper evaluates the ability of dividend ratios to predict the equity premium. We conduct an in and out-of-sample comparative study and apply the Goyal and Welch (2003) graphical method to equity premia derived from the UK FTSE All-Share and the S&P 500 indices. Preliminary in-sample univariate regressions reveal that in both markets the equity premium contains an element of predictability. However, the considered out-of-sample models outperform the historical moving average only in the UK context. This is confirmed by the graphical diagnostic which further indicates that dividend ratios are useful predictors of UK excess returns. Our paper provides a possible explanation of why dividend ratios might be more informative in the UK market by linking these findings to the disappearing dividend phenomenon. Finally, Campbell and Shiller (1988) identities are employed to account for the time-varying properties of the dividend ratio and dividend growth processes. It is shown that by instrumenting the models with the identities, forecasting ability can be further improved.

Suggested Citation

  • Kellard, Neil M. & Nankervis, John C. & Papadimitriou, Fotios I., 2010. "Predicting the equity premium with dividend ratios: Reconciling the evidence," Journal of Empirical Finance, Elsevier, vol. 17(4), pages 539-551, September.
  • Handle: RePEc:eee:empfin:v:17:y:2010:i:4:p:539-551
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    References listed on IDEAS

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    Cited by:

    1. Goodness C. Aye & Rangan Gupta & Mampho P. Modise, 2012. "Structural Breaks and Predictive Regressions Models of South African Equity Premium," Working Papers 201209, University of Pretoria, Department of Economics.
    2. Nuno Silva, 2015. "Time-Varying Stock Return Predictability: The Eurozone Case," Notas Económicas, Faculty of Economics, University of Coimbra, issue 41, pages 28-38, June.
    3. repec:eee:jimfin:v:80:y:2018:i:c:p:59-74 is not listed on IDEAS
    4. Rapach, David & Zhou, Guofu, 2013. "Forecasting Stock Returns," Handbook of Economic Forecasting, Elsevier.
    5. Nuno Silva, 2013. "Equity Premia Predictability in the EuroZone," GEMF Working Papers 2013-22, GEMF, Faculty of Economics, University of Coimbra.
    6. McMillan, David G., 2014. "Stock return, dividend growth and consumption growth predictability across markets and time: Implications for stock price movement," International Review of Financial Analysis, Elsevier, vol. 35(C), pages 90-101.
    7. Charles, Amélie & Darné, Olivier & Kim, Jae H., 2017. "International stock return predictability: Evidence from new statistical tests," International Review of Financial Analysis, Elsevier, pages 97-113.
    8. Guidolin, Massimo & McMillan, David G. & Wohar, Mark E., 2013. "Time varying stock return predictability: Evidence from US sectors," Finance Research Letters, Elsevier, vol. 10(1), pages 34-40.
    9. repec:eee:empfin:v:43:y:2017:i:c:p:159-184 is not listed on IDEAS

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