Scandinavian Working Papers in Economics
Working Papers in Economics,
University of Gothenburg, Department of Economics
No 768: Testing Return Predictability with the Dividend-Growth Equation: An Anatomy of the Dog
Erik Hjalmarsson () and Tamás Kiss ()
Additional contact information
Erik Hjalmarsson: Department of Economics, School of Business, Economics and Law, Göteborg University, Postal: P.O. Box 640, SE 40530 GÖTEBORG, Sweden
Tamás Kiss: Department of Economics, School of Business, Economics and Law, Göteborg University, Postal: P.O. Box 640, SE 40530 GÖTEBORG, Sweden
Abstract: The dividend-growth based test of return predictability, proposed by Cochrane[2008, Review of Financial Studies 21, 1533-1575], is similar to a likelihood-based test of the standard return-predictability model, treating the autoregressive parameter of the dividend-price ratio as known. In comparison to standard OLS-based inference, both tests achieve power gains from a strong use of the exact value postulated for the autoregressive parameter. When compared to the likelihood-based test, there are no power advantages for the dividend-growth based test. In common implementations, with the autoregressive parameter set equal to the corresponding OLS estimate, Cochrane's test also suffers from severe size distortions.
Keywords: Predictive regressions; Present-value relationship; Stock-return predictability
26 pages, June 2019
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