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Inflation illusion and the dividend yield: evidence from the UK

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  • Daniella Acker
  • Nigel Duck

Abstract

We report evidence that the UK dividend yield and expected inflation are positively correlated from 1962 to 1997, but negatively correlated subsequently. Using a commonly used VAR (vector auto-regression)-based procedure we find strong evidence that the positive correlation is caused both by inflation illusion and the effect of inflation on required rates of return. We also find some evidence that it is caused by inflation rationally reducing expected real dividend growth. We find that Chen and Zhao's (2009. "Return Decomposition." Review of Financial Studies 22 (12): 5213-5249) criticism of the VAR-based procedure has little empirical relevance but that the procedure can be highly sensitive to the choice of data period.

Suggested Citation

  • Daniella Acker & Nigel Duck, 2014. "Inflation illusion and the dividend yield: evidence from the UK," The European Journal of Finance, Taylor & Francis Journals, vol. 20(12), pages 1230-1245, December.
    • Handle: RePEc:taf:eurjfi:v:20:y:2014:i:12:p:1230-1245
    DOI: 10.1080/1351847X.2013.784207
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