A New Approach to Connecting the Dividend-Price Ratio and Stock Returns
作者: Wenting Liao
2026-04摘要: There is a long-lasting debate on the performance of dividend-price ratio on the stock returns predictability. Most of the literature argues that the predictability decreases after the 1990s. Since Campbell-Shiller decomposition shows that the dividendprice ratio contains the information of both the future returns and future dividend growth, a linear predictive regression of stock returns on the dividend-price ratio may generate biased results due to the measurement error or omitted variables issues. Therefore, this paper proposes a new approach to study the nonlinear Granger causality of dividend-price ratio on stock returns. We conduct an unobserved component model and connect stock returns and the dividend-price ratio through their innovations. We show that our model can be represented by a reduced-form ARMAX process, and it can increase the in-sample predictability for all the sample periods.