Dividend Yields and Stock Returns: Evidence from a Country without Taxes

Abstract

The positive relation between dividend yields and stock returns in the US market is well documented in recent research. However, the cause(s) of the dividend yield effect is still unknown. On the one hand, the effect can be attributed to tax as predicted in the Brennan CAPM (Brennan (1970)). On the other hand, dividend yield can proxy for omitted risk factors or variables. We document a robust dividend yield effect in the Hong Kong market where neither dividend income nor capital gains are taxed. The effect is persistent in different sub-samples by time period or by market capitalization. The yield effect is economically significant. A one percent difference in dividend yields is associated with about a two percent difference in risk-adjusted returns. While not ruling out the tax explanation, our results show there are non-tax (unknown) factors that cause the dividend yield effect.