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

Erik Hjalmarsson () and Tamas Kiss
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Erik Hjalmarsson: Department of Economics, School of Business, Economics and Law, Göteborg University, Postal: P.O. Box 640, SE 40530 GÖTEBORG, Sweden, https://economics.gu.se/

No 768, Working Papers in Economics from University of Gothenburg, Department of Economics

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.

Keywords: Predictive regressions; Present-value relationship; Stock-return predictability (search for similar items in EconPapers)
JEL-codes: C22 G12 (search for similar items in EconPapers)
Pages: 26 pages
Date: 2019-06
New Economics Papers: this item is included in nep-ecm
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