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Dividend Growth Does Not Help Predict Returns Compared To Likelihood-Based Tests: An Anatomy of the Dog

Erik Hjalmarsson and Tamás Kiss

Critical Finance Review, 2021, vol. 10, issue 3, 445-464

Abstract: The dividend-growth based test of return predictability, proposed by Cochrane (2008), is similar to a likelihood-based test of the standard return-predictability model, treating the autoregressive (AR) parameter of the dividend-price ratio as known. In comparison to standard OLS-based inference, both tests can achieve power gains by using restrictions or prior information on the value of the AR parameter. When compared to the likelihood-based test, there are no power advantages for the dividend-growth based test. In common implementations, with the AR parameter set equal to the corresponding OLS estimate, Cochrane’s test suffers from severe size distortions.

Keywords: Predictive regressions; Present-value relationship; Stock-return predictability (search for similar items in EconPapers)
JEL-codes: C22 G1 (search for similar items in EconPapers)
Date: 2021
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