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Stock return predictability and dividend-price ratio: a nonlinear approach

Author

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  • David G. McMillan

    (School of Management, University of St. Andrews, Scotland, UK)

  • Mark E. Wohar

    (Department of Economics, University of Nebraska at Omaha, Omaha, USA)

Abstract

This paper examines the forecasting ability of the dividend-price ratio for international stock market returns. Hitherto, existing research has only considered this issue in sample and in a linear framework. Hence, this paper provides the first systematic study of non-linear forecasting within the present value model context. Using an asymmetric variant of the popular exponential smooth-transition (ESTR) model we demonstrate the superior forecasting ability for the G7 markets over both a linear and symmetric ESTR model on the basis of a variety of forecast performance tests. In particular, the asymmetric-ESTR model provides improved mean forecast error metrics that are largely significant on the basis of forecast equality tests. Furthermore, in a trading rule exercise this models provides superior trading returns. As a final exercise we compare the forecasting performance of the individual models with those obtained through forecast combination. These results support the individual models on the basis of forecast error tests but suggest the combination strategy may be more profitable. These results are of importance not only for model builders but also for market participants looking to undertake active investment strategies. Copyright © 2009 John Wiley & Sons, Ltd.

Suggested Citation

  • David G. McMillan & Mark E. Wohar, 2010. "Stock return predictability and dividend-price ratio: a nonlinear approach," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 15(4), pages 351-365.
  • Handle: RePEc:ijf:ijfiec:v:15:y:2010:i:4:p:351-365
    DOI: 10.1002/ijfe.401
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    File URL: http://hdl.handle.net/10.1002/ijfe.401
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    References listed on IDEAS

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    Cited by:

    1. McMillan, David G., 2013. "Consumption and stock prices: Evidence from a small international panel," Journal of Macroeconomics, Elsevier, vol. 36(C), pages 76-88.
    2. repec:kea:keappr:ker-20180701-34-2-05 is not listed on IDEAS
    3. Vicente Esteve & Manuel Navarro-Ibáñez & María A. Prats, 2013. "The present value model of US stock prices revisited: long-run evidence with structural breaks, 1871-2010," Working Papers 04/13, Instituto Universitario de Análisis Económico y Social.
    4. repec:taf:oaefxx:v:4:y:2016:i:1:p:1178363 is not listed on IDEAS
    5. 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 1305, Department of Applied Economics II, Universidad de Valencia.
    6. repec:spr:empeco:v:53:y:2017:i:4:d:10.1007_s00181-016-1171-8 is not listed on IDEAS
    7. Kurmaş Akdoğan, 2015. "Unemployment Hysteresis and Structural Change in Europe," EY International Congress on Economics II (EYC2015), November 5-6, 2015, Ankara, Turkey 266, Ekonomik Yaklasim Association.
    8. 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.

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