IDEAS home Printed from https://ideas.repec.org/p/boe/boeewp/244.html
   My bibliography  Save this paper

Long-horizon equity return predictability: some new evidence for the United Kingdom

Author

Listed:
  • Anne Vila Wetherilt
  • Simon Wells

Abstract

This paper revisits the issue of long-horizon equity return predictability for the United Kingdom in the context of the dynamic dividend discount model of Campbell and Shiller. This model attributes predictable variation in equity prices to predictable variation in expected returns. The model is supported by the theoretical asset pricing literature, which shows how the variation in expected returns can be related to investors' time-varying preferences for risk. The paper considers various empirical specifications that are consistent with the Campbell and Shiller model and finds that they are supported by UK equity data. In particular, there is weak evidence that the dividend yield has predictive ability for long-horizon excess returns. The paper also examines some of the econometric issues brought up by recent research, in particular the small-sample bias, and applies appropriate statistical corrections. It further shows that the model's predictive ability depends greatly on the sample period over which the model is estimated.

Suggested Citation

  • Anne Vila Wetherilt & Simon Wells, 2004. "Long-horizon equity return predictability: some new evidence for the United Kingdom," Bank of England working papers 244, Bank of England.
  • Handle: RePEc:boe:boeewp:244
    as

    Download full text from publisher

    File URL: http://www.bankofengland.co.uk/research/Documents/workingpapers/2004/WP244.pdf
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Kevin D. Hoover & Stephen J. Perez, 1999. "Data mining reconsidered: encompassing and the general-to-specific approach to specification search," Econometrics Journal, Royal Economic Society, vol. 2(2), pages 167-191.
    2. repec:bla:jfinan:v:53:y:1998:i:5:p:1563-1587 is not listed on IDEAS
    3. Hansen, Lars Peter & Hodrick, Robert J, 1980. "Forward Exchange Rates as Optimal Predictors of Future Spot Rates: An Econometric Analysis," Journal of Political Economy, University of Chicago Press, vol. 88(5), pages 829-853, October.
    4. Campbell, John Y, 1991. "A Variance Decomposition for Stock Returns," Economic Journal, Royal Economic Society, vol. 101(405), pages 157-179, March.
    5. Pesaran, M. Hashem & Timmermann, Allan, 2002. "Market timing and return prediction under model instability," Journal of Empirical Finance, Elsevier, vol. 9(5), pages 495-510, December.
    6. John Y. Campbell & Robert J. Shiller, 1988. "Stock Prices, Earnings and Expected Dividends," Cowles Foundation Discussion Papers 858, Cowles Foundation for Research in Economics, Yale University.
    7. John Y. Campbell & Robert J. Shiller, 2001. "Valuation Ratios and the Long-Run Stock Market Outlook: An Update," NBER Working Papers 8221, National Bureau of Economic Research, Inc.
    8. John Y. Campbell, Robert J. Shiller, 1988. "The Dividend-Price Ratio and Expectations of Future Dividends and Discount Factors," The Review of Financial Studies, Society for Financial Studies, vol. 1(3), pages 195-228.
    9. Steven A. Sharpe, 2002. "Reexamining Stock Valuation and Inflation: The Implications Of Analysts' Earnings Forecasts," The Review of Economics and Statistics, MIT Press, vol. 84(4), pages 632-648, November.
    10. Martin Lettau & Sydney Ludvigson, 2001. "Consumption, Aggregate Wealth, and Expected Stock Returns," Journal of Finance, American Finance Association, vol. 56(3), pages 815-849, June.
    11. Lettau, Martin & Ludvigson, Sydney C., 2005. "Expected returns and expected dividend growth," Journal of Financial Economics, Elsevier, vol. 76(3), pages 583-626, June.
    12. John Y. Campbell & John Cochrane, 1999. "Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," Journal of Political Economy, University of Chicago Press, vol. 107(2), pages 205-251, April.
    13. Fama, Eugene F. & French, Kenneth R., 1988. "Dividend yields and expected stock returns," Journal of Financial Economics, Elsevier, vol. 22(1), pages 3-25, October.
    14. Stambaugh, Robert F., 1999. "Predictive regressions," Journal of Financial Economics, Elsevier, vol. 54(3), pages 375-421, December.
    15. Amit Goyal & Ivo Welch, 2003. "Predicting the Equity Premium with Dividend Ratios," Management Science, INFORMS, vol. 49(5), pages 639-654, May.
    16. repec:bla:jfinan:v:43:y:1988:i:3:p:661-76 is not listed on IDEAS
    17. Hodrick, Robert J, 1992. "Dividend Yields and Expected Stock Returns: Alternative Procedures for Inference and Measurement," The Review of Financial Studies, Society for Financial Studies, vol. 5(3), pages 357-386.
    18. Lior Menzly & Tano Santos & Pietro Veronesi, 2004. "Understanding Predictability," Journal of Political Economy, University of Chicago Press, vol. 112(1), pages 1-47, February.
    19. Amit Goyal & Ivo Welch, 2003. "Predicting the Equity Premium with Dividend Ratios," Management Science, INFORMS, vol. 49(5), pages 639-654, May.
    20. Froot, Kenneth A & Obstfeld, Maurice, 1991. "Intrinsic Bubbles: The Case of Stock Prices," American Economic Review, American Economic Association, vol. 81(5), pages 1189-1214, December.
    21. Lucy Ackert & William Hunter, 2001. "An Empirical Examination of the Price-Dividend Relation with Dividend Management," Journal of Financial Services Research, Springer;Western Finance Association, vol. 19(2), pages 115-129, April.
    22. John B. Carlson & Eduard A. Pelz & Mark E. Wohar, 2001. "Will the valuation ratios revert to their historical means? Some evidence from breakpoint tests," Working Papers (Old Series) 0113, Federal Reserve Bank of Cleveland.
    23. Wayne E. Ferson & Sergei Sarkissian & Timothy T. Simin, 2003. "Spurious Regressions in Financial Economics?," Journal of Finance, American Finance Association, vol. 58(4), pages 1393-1413, August.
    24. Granger, C. W. J. & Newbold, P., 1974. "Spurious regressions in econometrics," Journal of Econometrics, Elsevier, vol. 2(2), pages 111-120, July.
    25. repec:bla:jfinan:v:58:y:2003:i:4:p:1393-1414 is not listed on IDEAS
    26. Fama, Eugene F. & French, Kenneth R., 1989. "Business conditions and expected returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 25(1), pages 23-49, November.
    27. Pesaran, M Hashem & Timmermann, Allan, 1995. "Predictability of Stock Returns: Robustness and Economic Significance," Journal of Finance, American Finance Association, vol. 50(4), pages 1201-1228, September.
    28. William R. Nelson, 1999. "The aggregate change in shares and the level of stock prices," Finance and Economics Discussion Series 1999-08, Board of Governors of the Federal Reserve System (U.S.).
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Ai Deng, 2014. "Understanding Spurious Regression in Financial Economics," Journal of Financial Econometrics, Oxford University Press, vol. 12(1), pages 122-150.
    2. Simon Price & Christoph Schleicher, 2006. "Returns to equity, investment and Q: evidence from the United Kingdom," Bank of England working papers 310, Bank of England.
    3. Catherine Georgiou, 2020. "The British Stock Market under the Structure of Market Capitalization Value: New Evidence on its Predictive Content," International Journal of Business and Economic Sciences Applied Research (IJBESAR), International Hellenic University (IHU), Kavala Campus, Greece (formerly Eastern Macedonia and Thrace Institute of Technology - EMaTTech), vol. 13(3), pages 56-69, December.
    4. Simon Price & Christoph Schleicher, 2005. "Returns To Equity, Investment And Q: Evidence From The Uk," Manchester School, University of Manchester, vol. 73(s1), pages 32-57, September.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Rangvid, Jesper, 2006. "Output and expected returns," Journal of Financial Economics, Elsevier, vol. 81(3), pages 595-624, September.
    2. Rapach, David & Zhou, Guofu, 2013. "Forecasting Stock Returns," Handbook of Economic Forecasting, in: G. Elliott & C. Granger & A. Timmermann (ed.), Handbook of Economic Forecasting, edition 1, volume 2, chapter 0, pages 328-383, Elsevier.
    3. Campbell, John Y., 2003. "Consumption-based asset pricing," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, edition 1, volume 1, chapter 13, pages 803-887, Elsevier.
    4. Neil Kellard & John Nankervis & Fotis Papadimitriou, 2007. "Predicting the UK Equity Premium with Dividend Ratios: An Out-Of-Sample Recursive Residuals Graphical Approach," Money Macro and Finance (MMF) Research Group Conference 2006 129, Money Macro and Finance Research Group.
    5. John Y. Campbell, 2008. "Viewpoint: Estimating the equity premium," Canadian Journal of Economics, Canadian Economics Association, vol. 41(1), pages 1-21, February.
    6. Chen, Nan-Kuang & Chen, Shiu-Sheng & Chou, Yu-Hsi, 2017. "Further evidence on bear market predictability: The role of the external finance premium," International Review of Economics & Finance, Elsevier, vol. 50(C), pages 106-121.
    7. Collard, Fabrice & Feve, Patrick & Ghattassi, Imen, 2006. "Predictability and habit persistence," Journal of Economic Dynamics and Control, Elsevier, vol. 30(11), pages 2217-2260, November.
    8. Engsted, Tom & Hyde, Stuart & Møller, Stig V., 2010. "Habit formation, surplus consumption and return predictability: International evidence," Journal of International Money and Finance, Elsevier, vol. 29(7), pages 1237-1255, November.
    9. Martin Lettau & Stijn Van Nieuwerburgh, 2008. "Reconciling the Return Predictability Evidence," The Review of Financial Studies, Society for Financial Studies, vol. 21(4), pages 1607-1652, July.
    10. Tim Bollerslev & George Tauchen & Hao Zhou, 2009. "Expected Stock Returns and Variance Risk Premia," The Review of Financial Studies, Society for Financial Studies, vol. 22(11), pages 4463-4492, November.
    11. Qi Liu & Libin Tao & Weixing Wu & Jianfeng Yu, 2017. "Short- and Long-Run Business Conditions and Expected Returns," Management Science, INFORMS, vol. 63(12), pages 4137-4157, December.
    12. Schrimpf, Andreas, 2010. "International stock return predictability under model uncertainty," Journal of International Money and Finance, Elsevier, vol. 29(7), pages 1256-1282, November.
    13. Puneet Handa, 2006. "Does Stock Return Predictability Imply Improved Asset Allocation and Performance? Evidence from the U.S. Stock Market (1954–2002)," The Journal of Business, University of Chicago Press, vol. 79(5), pages 2423-2468, September.
    14. Lettau, Martin & Ludvigson, Sydney C., 2005. "Expected returns and expected dividend growth," Journal of Financial Economics, Elsevier, vol. 76(3), pages 583-626, June.
    15. repec:grz:wpaper:2012-02 is not listed on IDEAS
    16. Golinski, Adam & Madeira, Joao & Rambaccussing, Dooruj, 2014. "Fractional Integration of the Price-Dividend Ratio in a Present-Value Model of Stock Prices," SIRE Discussion Papers 2015-79, Scottish Institute for Research in Economics (SIRE).
    17. Parastoo Mousavi, 2021. "Debt-by-Price Ratio, End-of-Year Economic Growth, and Long-Term Prediction of Stock Returns," Mathematics, MDPI, vol. 9(13), pages 1-18, July.
    18. Michael Cooper & Huseyin Gulen, 2006. "Is Time-Series-Based Predictability Evident in Real Time?," The Journal of Business, University of Chicago Press, vol. 79(3), pages 1263-1292, May.
    19. Golinski, Adam & Madeira, Joao & Rambaccussing, Dooruj, 2014. "Fractional Integration of the Price-Dividend Ratio in a Present-Value Model," MPRA Paper 58554, University Library of Munich, Germany.
    20. Wayne E. Ferson & Sergei Sarkissian & Timothy T. Simin, 2003. "Spurious Regressions in Financial Economics?," Journal of Finance, American Finance Association, vol. 58(4), pages 1393-1413, August.
    21. Shamsi Zamenjani, Azam, 2021. "Do financial variables help predict the conditional distribution of the market portfolio?," Journal of Empirical Finance, Elsevier, vol. 62(C), pages 327-345.

    More about this item

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:boe:boeewp:244. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Digital Media Team (email available below). General contact details of provider: https://edirc.repec.org/data/boegvuk.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.