Stock returns, dividend yield, and book-to-market ratio

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A dividend yield model has been widely used in previous research that relates stock market valuations to cash flow fundamentals. Given controversies about using dividends as a proxy for cash flows, a loglinear book-to-market model has recently been proposed. However, these models rely on the assumption that dividend yield and book-to-market ratio are both stationary, and empirical evidence for this is, at best, mixed. We develop a new model, the loglinear cointegration model, that explains future profitability and excess stock returns in terms of a linear combination of log book-to-market ratio and log dividend yield. The loglinear cointegration model performs better than the log dividend yield model and the log book-to-market model in terms of cross-equation restriction tests and forecasting performance comparisons. The superior performance of the loglinear cointegration model suggests that the linear combination may be a better indicator of intrinsic fundamentals than the dividend yield or the book-to-market ratio separately. Published by Elsevier B.V.
Publisher
ELSEVIER SCIENCE BV
Issue Date
2007-02
Language
English
Article Type
Article
Keywords

CROSS-SECTION; TIME-SERIES; COINTEGRATION VECTORS; RISK; MODELS; TESTS; VALUATION; PREDICTABILITY; EXPLANATIONS; HYPOTHESIS

Citation

JOURNAL OF BANKING & FINANCE, v.31, no.2, pp.455 - 475

ISSN
0378-4266
DOI
10.1016/j.jbankfin.2006.07.012
URI
http://hdl.handle.net/10203/89931
Appears in Collection
RIMS Journal Papers
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