Expected Returns and Expected Dividend Growth

Martin Lettau and Sydney Ludvigson

No 3507, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: We develop a consumption-based present value relation that is a function of future dividend growth. Using data on aggregate consumption and measures of the dividend payments from aggregate wealth, we show that changing forecasts of dividend growth make an important contribution to fluctuations in the US stock market, despite the failure of the dividend-price ratio to uncover such variation. In addition, these dividend forecasts are found to co-vary with changing forecasts of excess stock returns. The variation in expected dividend growth we uncover is positively correlated with ?business cycle? variation in expected returns, and the results suggest that a substantial fraction of the variation in expected dividend growth is common to variation in expected excess returns. Movements in expected dividend growth that are entirely common to movements in expected returns have no effect on the log dividend-price ratio. An implication of these findings is that the log dividend-price ratio will have difficulty predicting both dividend growth and excess returns at business cycle frequencies. Such a failure of predictive power is not an indication that risk-premia are constant, however. On the contrary, the results presented here imply that the log dividend-price ratio will have difficulty revealing business cycle variation in both the equity risk-premium and expected dividend growth precisely because expected returns fluctuate at those frequencies, and co-vary with changing forecasts of dividend growth. The findings imply that both the market risk-premium and expected dividend growth vary considerably more than what can be revealed using the log dividend-price ratio alone as a predictive variable.

Keywords: Dividend growth; Consumption; Cointegration (search for similar items in EconPapers)
JEL-codes: G10 G12 (search for similar items in EconPapers)
Date: 2002-08
New Economics Papers: this item is included in nep-cfn
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

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Related works:
Journal Article: Expected returns and expected dividend growth (2005)
Working Paper: Expected Returns and Expected Dividend Growth (2003)
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