Time-Varying Predictability for Stock Returns, Dividend Growth and Consumption Growth

26 Pages Posted: 10 Sep 2014

Date Written: September 9, 2014

Abstract

Using a state-space model, this paper examines time-variation in the predictive regressions for stock returns, dividend growth and consumption growth. Moreover, we linked time-variation explicitly to movements in economic factors that can account for risk and cash flow. Results support the view that stock return predictability is enhanced when risk is high (negative growth, higher volatility and positive growth/return covariance). In contrast, dividend growth and consumption growth predictability is enhanced during economic expansions. These results are supported by sub-sample analysis and a VAR approach. Furthermore, these latter exercises may uncover differences in the stock return predictability relationship when viewed over different time horizons. Overall, the paper contributes to the literature by highlighting the different nature of returns predictability, which arises largely through the risk channel and dividend and consumption growth predictability, which arise through the cash flow channel.

Keywords: Stock Returns, Predictability, Time-Variation, State Space, Dividend Growth, Consumption Growth, Asset Price Movement

JEL Classification: C22, G12

Suggested Citation

McMillan, David G., Time-Varying Predictability for Stock Returns, Dividend Growth and Consumption Growth (September 9, 2014). Available at SSRN: https://ssrn.com/abstract=2493703 or http://dx.doi.org/10.2139/ssrn.2493703

David G. McMillan (Contact Author)

University of Stirling ( email )

Stirling, Scotland FK9 4LA
United Kingdom

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