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Demographics and fluctuations in Dividend/Price

  • Andrea Tamoni
  • Arie E.Gozluklu
  • Carlo A.Favero

The dynamic dividend growth model (Campbell&Shiller, 1988) linking the log dividend yield to future expected dividend growth and stock market returns has been extensively used in the literature for forecasting stock returns. The empirical evidence on the performance of the model is mixed as its strength varies with the sample choice. This model is derived on the assumption of stationary dpt, dividend-yield. The empirical validity of such hypothesis has been challenged in recent literature (Lettau&Van Nieuwerburgh, 2007) with strong evidence on a time varying mean, due to breaks, in this financial ratio. In this paper, we show that the slowly evolving mean toward which the dividend price ratio is reverting is determined by demographic factors. We also show that a forecasting model based on demographics and a demand factor as captured by excess consumption in the sense of Lettau and Ludvigson(2004) overperforms virtually all alternative models proposed in the empirical literature in the framework of the dynamic dividend growth model. Finally, we exploit the predictability of demographic factors to project the equity risk premium up to 2050.

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Paper provided by IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University in its series Working Papers with number 345.

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Date of creation: 2008
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Handle: RePEc:igi:igierp:345
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  1. Andrew B. Abel, 2002. "The Effects of a Baby Boom on Stock Prices and Capital Accumulation in the Presence of Social Security," NBER Working Papers 9210, National Bureau of Economic Research, Inc.
  2. Martin Lettau & Sydney Ludvigson, 2003. "Understanding Trend and Cycle in Asset Values: Reevaluating the Wealth Effect on Consumption," NBER Working Papers 9848, National Bureau of Economic Research, Inc.
  3. Bakshi, Gurdip S & Chen, Zhiwu, 1994. "Baby Boom, Population Aging, and Capital Markets," The Journal of Business, University of Chicago Press, vol. 67(2), pages 165-202, April.
  4. Martin Lettau & Sydney Ludvigson, 2003. "Expected Returns and Expected Dividend Growth," NBER Working Papers 9605, National Bureau of Economic Research, Inc.
  5. Lettau, Martin & Ludvigson, Sydney, 1999. "Consumption, Aggregate Wealth and Expected Stock Returns," CEPR Discussion Papers 2223, C.E.P.R. Discussion Papers.
  6. Kydland, Finn E & Prescott, Edward C, 1982. "Time to Build and Aggregate Fluctuations," Econometrica, Econometric Society, vol. 50(6), pages 1345-70, November.
  7. Campbell, John & Shiller, Robert, 1988. "Stock Prices, Earnings, and Expected Dividends," Scholarly Articles 3224293, Harvard University Department of Economics.
  8. Owen Lamont, 1998. "Earnings and Expected Returns," Journal of Finance, American Finance Association, vol. 53(5), pages 1563-1587, October.
  9. Lewellen, Jonathan, 2004. "Predicting returns with financial ratios," Journal of Financial Economics, Elsevier, vol. 74(2), pages 209-235, November.
  10. Shmuel Kandel & Robert F. Stambaugh, . "Modeling Expected Stock Returns for Long and Short Horizons," Rodney L. White Center for Financial Research Working Papers 42-88, Wharton School Rodney L. White Center for Financial Research.
  11. Andrew Ang & Angela Maddaloni, 2003. "Do Demographic Changes Affect Risk Premiums? Evidence from International Data," NBER Working Papers 9677, National Bureau of Economic Research, Inc.
  12. Johansen, Soren, 1991. "Estimation and Hypothesis Testing of Cointegration Vectors in Gaussian Vector Autoregressive Models," Econometrica, Econometric Society, vol. 59(6), pages 1551-80, November.
  13. Amit Goyal & Ivo Welch, 2004. "A Comprehensive Look at the Empirical Performance of Equity Premium Prediction," Yale School of Management Working Papers amz2412, Yale School of Management, revised 01 Jan 2006.
  14. Juselius, Katarina, 2006. "The Cointegrated VAR Model: Methodology and Applications," OUP Catalogue, Oxford University Press, number 9780199285679, March.
  15. Martin Lettau & Stijn Van Nieuwerburgh, 2006. "Reconciling the Return Predictability Evidence," NBER Working Papers 12109, National Bureau of Economic Research, Inc.
  16. Henrik Hansen & Søren Johansen, 1999. "Some tests for parameter constancy in cointegrated VAR-models," Econometrics Journal, Royal Economic Society, vol. 2(2), pages 306-333.
  17. Andrew Ang & Geert Bekaert, 2001. "Stock Return Predictability: Is it There?," NBER Working Papers 8207, National Bureau of Economic Research, Inc.
  18. Stefano DellaVigna & Joshua M. Pollet, 2007. "Demographics and Industry Returns," American Economic Review, American Economic Association, vol. 97(5), pages 1667-1702, December.
  19. Johansen, Soren, 1988. "Statistical analysis of cointegration vectors," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 231-254.
  20. Goyal, Amit, 2004. "Demographics, Stock Market Flows, and Stock Returns," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 39(01), pages 115-142, March.
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