Dividend Growth Predictability and the Price–Dividend Ratio

Asymptotic tests over-reject the null of no predictability in present-value models. We develop a nonparametric testing approach in state-space models, implying reliable finite sample inference under weak assumptions on price–dividend ratio and dividend shocks. We find sharp evidence of return predictability in postwar U.S. data but less consistent evidence of dividend predictability, which is significant only using cash-flow proxies reflecting information from mergers and acquisitions. These findings reconcile the diverging conclusions of present-value models and common predictive regressions in a way that is robust to the choice of the predictive variables, the sample period, and alternative cash-flow proxies.