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http://www.jstor.org Wed May 2 16:18:43 2007
THE JOURNAL OF FINANCE
VOL. XLVIII, NO. 2
Testing the Predictive Power of Dividend Yields
WILLIAM N. GOETZMANN and PHII,IPPE JORION*
This paper reexamines the ability of dividend yields to predict long-horizon stock returns. We use the bootstrap methodology, as well as simulations, to examine the distribution of test statistics under the null hypothesis of no forecasting ability. These experiments are constructed so as to maintain the dynamics of regressions with lagged dependent variables over long horizons. We find that the empirically observed statistics are well within the 95% bounds of their simulated distributions. Overall there is no strong statistical evidence indicating that dividend yields can be used to forecast stock returns.
A NUMBER OF RECENT studies appear to provide empirical support for the traditional use of the dividend-price ratio as a measure of expected stock returns. Rozeff (19841, for instance, finds that the ratio of the dividend yield to the short-term interest rate explains a significant fraction of movements in annual stock returns. Fama and French (1988) use a regression framework to show that the dividend yield predicts a significant proportion of multiple year returns to the NYSE index. They further observe that the explanatory power of the dividend yield increases in the time horizon of the returns; over four-year horizons, R2's range from a low of 19% to an astonishingly high value of 64%. Similar results are reported by Flood, Hodrick, and Kaplan (1987) and Campbell and Shiller (1988). The apparent predictability of market returns from past values of dividend yields is regarded by Rozeff (1984) as support for the rejection of the random walk model of stock prices, and by Fama and French (1988) as support for the cyclical behavior of expected returns. Flood, Hodrick, and Kaplan (1987) interpret their results as support for time-varying expected returns to stocks. The direct, and somewhat disturbing, implication of most of these studies is that significant components of long-term stock returns may be predictable using combinations of past returns and macroeconomic variables. There are a number of reasons, however, why these results should be regarded with caution. Given the persistent patterns of dividend payments, movements in dividend yields are essentially dominated by movements in prices. Therefore, the forecasting regressions suffer from biases due to the 'Columbia University and University of California a t Irvine, respectively. We wish to thank Bob Hodrick and Stephen Ross for their advice. Useful comments were also received from Stephen Brown, John Campbell,...