Management Science · 2003 · 807 citations · 27 references
Dividend YieldsTime Series EconometricsEconomic ForecastingAsset PricingEconomic AnalysisFinancial EconometricsQuantitative ManagementPayout PolicyEconomicsDividend-price RatioAccountingQuantitative FinanceForecastingFinanceFinancial AnalyticsFinancial EconomicsDividend RatiosBusinessStock Market PredictionFinancial Forecast
Cochrane’s 1997 identity that dividend ratios predict long‑run growth or returns holds only over horizons longer than 5–10 years. The paper proposes a simple, recursive residuals‑based graphical method to assess the predictive power of common equity‑premium and stock‑market time‑series forecasting regressions. The method employs recursive residuals plotted out‑of‑sample to evaluate forecasting regressions. The study finds that dividend ratios had no predictive power before the 1990s, with any apparent ability driven by 1973–74, and that increasing persistence of the dividend‑price ratio explains their failure to predict equity premia, while over short horizons dividend yields mainly forecast themselves.
Our paper suggests a simple, recursive residuals (out-of-sample) graphical approach to evaluating the predictive power of popular equity premium and stock market time-series forecasting regressions. When applied, we find that dividend ratios should have been known to have no predictive ability even prior to the 1990s, and that any seeming ability even then was driven by only two years, 1973 and 1974. Our paper also documents changes in the time-series processes of the dividends themselves and shows that an increasing persistence of dividend-price ratio is largely responsible for the inability of dividend ratios to predict equity premia. Cochrane's (1997) accounting identity—that dividend ratios have to predict long-run dividend growth or stock returns—empirically holds only over horizons longer than 5–10 years. Over shorter horizons, dividend yields primarily forecast themselves.
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