Predictive Regressions: A Present-Value Approach

Abstract

We propose a latent-variables approach within a present-value model to estimate the expected returns and expected dividend growth rates of the aggregate stock market. This approach aggregates information contained in the whole history of the price-dividend ratio and dividend growth rates to obtain predictors for future returns and dividend growth rates. We find that both returns and dividend growth rates are predictable with R-squared values ranging from 8.2-8.9 percent for returns and 13.9-31.6 percent for dividend growth rates. Both expected returns and expected dividend growth rates have a persistent component, but expected returns are more persistent than expected dividend growth rates.