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Testing Return Predictability with the Dividend-Growth Equation: An Anatomy of the Dog

Author

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  • Hjalmarsson, Erik

    (Department of Economics, School of Business, Economics and Law, Göteborg University)

  • Kiss, Tamás

    (Department of Economics, School of Business, Economics and Law, Göteborg University)

Abstract

The dividend-growth based test of return predictability, proposed by Cochrane[2008, Review of Financial Studies 21, 1533-1575], is similar to a likelihood-based test of the standard return-predictability model, treating the autoregressive parameter of the dividend-price ratio as known. In comparison to standard OLS-based inference, both tests achieve power gains from a strong use of the exact value postulated for the autoregressive parameter. When compared to the likelihood-based test, there are no power advantages for the dividend-growth based test. In common implementations, with the autoregressive parameter set equal to the corresponding OLS estimate, Cochrane's test also suffers from severe size distortions.

Suggested Citation

  • Hjalmarsson, Erik & Kiss, Tamás, 2019. "Testing Return Predictability with the Dividend-Growth Equation: An Anatomy of the Dog," Working Papers in Economics 768, University of Gothenburg, Department of Economics.
    • Handle: RePEc:hhs:gunwpe:0768
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    File URL: http://hdl.handle.net/2077/60486
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    Keywords

    Predictive regressions; Present-value relationship; Stock-return predictability;
    All these keywords.

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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