Tug-of-War: Time-Varying Predictability of Stock Returns and Dividend Growth

Xiaoneng Zhu

Review of Finance, 2015, vol. 19, issue 6, 2317-2358

Abstract: We propose a regime-switching present-value model with latent variables to jointly investigate the predictability of stock returns and dividend growth. We find that both return predictability and dividend growth predictability are time-varying. Interestingly, the predictability of stock returns and dividend growth is a tug-of-war contest: when dividend growth is highly predictable in the high-volatility regime, stock returns are largely unpredictable; in contrast, when dividend growth is less predictable in the low-volatility regime, stock returns are significantly predictable. We also investigate macroeconomic determinants of regime switches and find that two regimes are intimately related to macroeconomic risk and economic activity.

Date: 2015
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