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Nonparameter Method

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Words 10485
Pages 42
Yale ICF Working Paper No. 02-04
November 21, 2002

Amit Goyal
Goizueta Business School at Emory
Ivo Welch
Yale School of Management

This paper can be downloaded without charge from the
Social Science Research Network Electronic Paper Collection: Predicting the Equity Premium
(With Dividend Ratios)∗
Amit Goyal†
Goizueta Business School at Emory

Ivo Welch‡
Yale School of Management and NBER

November 21, 2002

Our paper suggests a simple recursive residuals (out-of-sample) graphical approach to evaluating the predictive power of popular equity premium and stock market time-series forecasting regressions. When applied, we find that dividend-ratios should have been known to have no predictive ability even prior to the 1990s, and that any seeming ability even then was driven by only two years, 1973 and 1974. Our paper also documents changes in the time-series processes of the dividends themselves and shows that an increasing persistence of dividend-price ratio is largely responsible for the inability of dividend ratios to predict equity premia. Cochrane (1997)’s accounting identity—that dividend ratios have to predict long-run dividend growth or stock returns— empirically holds only over horizons longer than 5–10 years. Over shorter horizons, dividend yields primarily forecast themselves.
JEL Classification: G12, G14.

Forthcoming: Management Science.

The paper and its data is available from We thank Eugene
Fama, Ken French, Will Goetzman, Shingo Goto, Charles Lee, Richard Roll, Pedro Santa-Clara,
Eduardo Schwartz, Jay Shanken, Robert Stambaugh, and especially Luis Viceira and Tuomo O.
Vuolteenaho for feedback. Finally, we are grateful especially to the editor Ravi Jagannathan, both for feedback and encouragement.

Contact: Amit...

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