Working Paper: NBER ID: w16183
Authors: Anisha Ghosh; George M. Constantinides
Abstract: The predictability of the market return and dividend growth is addressed in an equilibrium model with two regimes. A state variable that drives the conditional means of the aggregate consumption and dividend growth rates follows different time-series processes in the two regimes. In linear predictive regressions over 1930-2009, the market return is predictable by the price-dividend ratio with R2 11.7% if the probability of being in the first regime exceeds 50%; and dividend growth is predictable by the price-dividend ratio with R2 28.3% if the probability of being in the second regime exceeds 50%. The model-implied state variables perform significantly better at predicting the equity, size, and value premia, the aggregate consumption and dividend growth rates, and the variance of the market return than linear regressions with the market price-dividend ratio and risk free rate as predictive variables.
Keywords: predictability; returns; regime shifts; consumption growth; dividend growth
JEL Codes: E44; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| price-dividend ratio (G35) | market return (G19) |
| price-dividend ratio (G35) | dividend growth (G35) |
| regime shifts (P39) | predictability of returns (G17) |
| regime shifts (P39) | predictability of dividend growth (G35) |
| price-dividend ratio and risk-free rate (G12) | probability of being in the first regime (C29) |