When does the dividend-price ratio predict stock returns?

Abstract

If the dividend-price ratio becomes I(1) while stock returns are I(0), the unbalanced predictive regression makes the predictability test more likely to indicate that the dividend-price ratio has no predictive power. This might explain why the dividend-price ratio evidences strong predictive power during one period, while it exhibits weak or no predictive power at other times. Using international data, this paper demonstrates that the dividend-price ratio generally has predictive power for stock returns when both are I(0). However, this paper also shows that the dividend-price ratio loses its predictive power when it becomes I(1). The results are shown to be robust across countries. (C) 2009 Elsevier B.V. All rights reserved.