Stock Return Predictability: Is It There?
Coauthor(s): Geert Bekaert.
We examine the predictive power of the dividend yield for forecasting future excess returns, cashflows, and interest rates. The ability of the dividend yield to predict excess returns is best visible at short horizons with the short rate as an additional regressor. At short horizons, the short rate strongly negatively predicts excess returns, while at long horizons, the predictive power of the dividend yield is weak. These results are robust in international data and are
not due to lack of power. We formulate a present value model that matches the predictability evidence, which shows that while excess discount rates still dominate the variation in dividend yields, short rate movements also play a large role. Finally, we detect a strong role for the earnings yield as a predictive instrument, not for excess returns, but for future cashflows.
Source: Review of Financial Studies
Bekaert, Geert, and Andrew Ang. "Stock Return Predictability: Is It There?" Review of Financial Studies 20, no. 3 (2007): 651-707.