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Testing Return Predictability with the Dividend-Growth Equation: An Anatomy of the Dog

Report
Authors Erik Hjalmarsson
Tamás Kiss
Publisher University of Gothenburg
Place of publication Gothenburg
Publication year 2019
Published at Centre for Finance
Department of Economics
Language en
Links hdl.handle.net/2077/60486
Keywords Predictive regressions, Present-value relationship, Stock-return predictability
Subject categories Economics

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 pos- tulated 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.

Page Manager: Webmaster|Last update: 9/11/2012
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