Working Paper: NBER ID: w8666
Authors: Jay Shanken; Ane Tamayo
Abstract: In the asset pricing literature, time-variation in market expected excess return captured by financial ratios like dividend yield is typically viewed as a reflection of either changing risk, related to the business cycle, or irrational mispricing. Extending the work on asset allocation and dividend yield by Kandel and Stambaugh (1996) to accommodate variation in risk as well as expected return, we develop Bayesian methods to examine the interaction between the data and an investor's initial beliefs about the sources of return predictability. Although results vary with the subperiod examined, different views on the relative importance of these factors can have important implications for asset allocation between a stock index and a riskless asset. In general, however, the simple risk/return model of Merton (1980) explains very little of the yield-related return predictability observed.
Keywords: No keywords provided
JEL Codes: C11; G11; G12; G14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| time variation in expected excess returns (C22) | changing risk related to the business cycle (E32) |
| time variation in expected excess returns (C22) | irrational mispricing (G40) |
| higher dividend yields (G35) | perception of increased risk (D81) |
| perception of increased risk (D81) | decrease in optimal stock allocation (G11) |
| mispricing is the dominant factor (L11) | allocation resembles that under constant risk (D81) |
| shifts in dividend yields and returns (G35) | changes in investor beliefs (G41) |
| changes in investor beliefs (G41) | changes in asset allocation decisions (G11) |