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Understanding Predictability

Listed author(s):
  • Lior Menzly
  • Tano Santos
  • Pietro Veronesi
Registered author(s):

    We propose a general equilibrium model with multiple securities in which investors' risk preferences and expectations of dividend growth are time-varying. While time-varying risk preferences induce the standard positive relation between the dividend yield and expected returns, time-varying expected dividend growth induces a negative relation between them. These offsetting effects reduce the ability of the dividend yield to forecast returns and eliminate its ability to forecast dividend growth, as observed in the data. The model links the predictability of returns to that of dividend growth, suggesting specific changes to standard linear predictive regressions for both. The model's predictions are confirmed empirically.

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    File URL: http://dx.doi.org/10.1086/379934
    File Function: main text
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    Article provided by University of Chicago Press in its journal Journal of Political Economy.

    Volume (Year): 112 (2004)
    Issue (Month): 1 (February)
    Pages: 1-47

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    Handle: RePEc:ucp:jpolec:v:112:y:2004:i:1:p:1-47
    Contact details of provider: Web page: http://www.journals.uchicago.edu/JPE/

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    1. Hodrick, Robert J, 1992. "Dividend Yields and Expected Stock Returns: Alternative Procedures for Inference and Measurement," Review of Financial Studies, Society for Financial Studies, vol. 5(3), pages 357-386.
    2. Fama, Eugene F & French, Kenneth R, 1988. "Permanent and Temporary Components of Stock Prices," Journal of Political Economy, University of Chicago Press, vol. 96(2), pages 246-273, April.
    3. Gurdip S. Bakshi & Zhiwu Chen, 1996. "An Alternative Valuation Model for Contingent Claims," Yale School of Management Working Papers ysm78, Yale School of Management.
    4. John Y. Campbell, Robert J. Shiller, 1988. "The Dividend-Price Ratio and Expectations of Future Dividends and Discount Factors," Review of Financial Studies, Society for Financial Studies, vol. 1(3), pages 195-228.
    5. Detemple, Jerome B & Zapatero, Fernando, 1991. "Asset Prices in an Exchange Economy with Habit Formation," Econometrica, Econometric Society, vol. 59(6), pages 1633-1657, November.
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