FIN-02-024 |
NYU Stern School of Business |
September 2002
Martin Lettau and Sydney C. Ludvigson
ABSTRACT
We develop a consumption-based present value relation that is a function of future div-idend
growth. Using data on aggregate consumption and measures of the dividend pay-ments
from aggregate wealth, we show that changing forecasts of dividend growth make
an important contribution to uctuations in the U.S. stock market, despite the failure of
the dividend-price ratio to uncover such variation. In addition, these dividend forecasts
are found to covary with changing forecasts of excess stock returns. The variation in ex-pected
dividend growth we uncover is positively correlated with "business cycle" variation
in expected returns, and the results suggest that a substantial fraction of the variation in
expected dividend growth is common to variation in expected excess returns. Movements in
expected dividend growth that are entirely common to movements in expected returns have
no effect on the log dividend-price ratio.
An implication of these findings is that the log dividend-price ratio will have difficulty
predicting both dividend growth and excess returns at business cycle frequencies. Such a
failure of predictive power is not an indication that risk-premia are constant, however. On
the contrary, the results presented here imply that the log dividend-price ratio will have
difficulty revealing business cycle variation in both the equity risk-premium and expected
dividend growth precisely because expected returns uctuate at those frequencies, and covary
with changing forecasts of dividend growth. The findings imply that both the market risk-premium
and expected dividend growth vary considerably more than what can be revealed
using the log dividend-price ratio alone as a predictive variable.
Martin Lettau
Institution: Department of Finance, Stern School of Business, New York University, 44 West Fourth Street,
New York, NY 10012-1126
Telephone: 212-998-0378
Fax: 212-995-4233
Email: mlettau@stern.nyu.edu
Home Page: http://www.stern.nyu.edu/~mlettau
Sydney C. Ludvigson
Institution: Department of Economics, New York University, 269
Mercer Street, 7th Floor, New York, NY 10003
Telephone: 212-998-8927
Fax: 212-995-4168
Email: sydney.ludvigson@nyu.edu
Home Page: http://www.econ.nyu.edu/user/ludvigsons
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