Rediscover Predictability: A Duration-Based Approach
The ratio of long- to short-term dividend prices, “price ratio” ($pr_t$), predicts annual market return with an out-of-sample $R^2$ of 19%, subsuming the predictive power of price-dividend ratio ($pd_t$). After controlling for $pr_t$, $pd_t$ predicts dividend growth with an out-of-sample $R^2$ of 30%. Our results hold outside the U.S. An exponential-affine model shows that the key to our findings is the (lack of) persistence of expected dividend growth. We find the expected return is countercyclical and responds strongly to monetary policy shocks. As implied by ICAPM, shocks to $pr_t$, the expected-return proxy, are priced in the cross-section.
LBS Trans-Atlantic Doctoral Conference, Yale SOM, Econometric Society Annual Meeting, NFA Annual Meeting, Fall Finance Conference at UT Dallas, Örebro Workshop on Predicting Asset Returns, 16th Paris December Finance Meeting, HKUST Finance Symposium, 2019 RCFS/RAPS Conference at Baha Mar
16th Paris December Finance Meeting Best Paper Award