Stock Market Predictability: Global Evidence and an Explanation

Using a comprehensive dataset covering 34 countries from Datastream, we find that dividend-price ratio has a broad spectrum of forecasting abilities internationally. In some countries, such as the US, the dividend-price ratio is a powerful predictor of exclusively stock returns, whereas in others it is a powerful predictor of exclusively dividend growth rates. For many countries, however, the dividend-price ratio has some predictive power for both stock returns and dividend growth rates, although the relative degree of predictive power differs. We have provided an explanation for these differences in stock market predictabilities between countries. When a firm with a dominant shareholder is publicly traded, then the dominant shareholder determines cash-flow policy but the stochastic discount factor contained in the stock price may reflect the minority shareholders¡¯ stochastic discount factor. For this reason, the correlation between cash-flow and stochastic discount factor approaches zero as the disparity between voting rights and cash-flow rights increases. As a result, the stock price becomes more dependent on expected dividends than expected stock returns, and, therefore, the dividend-price ratio has a stronger predictive power for dividend growth. Consistent with our explanation, we find a strong positive relation between dividend growth predictability and disparity, but a significantly negative one between stock return predictability and disparity. These relations are found to be consistent across various robust tests.