Faculty Publications

Title

Stock returns, dividend yield, and book-to-market ratio

Document Type

Article

Keywords

Book-to-market ratio, Cointegration, Dividend yield, Present value model

Journal/Book/Conference Title

Journal of Banking and Finance

Volume

31

Issue

2

First Page

455

Last Page

475

Abstract

A dividend yield model has been widely used in previous research that relates stock market valuations to cash flow fundamentals. Given controversies about using dividends as a proxy for cash flows, a loglinear book-to-market model has recently been proposed. However, these models rely on the assumption that dividend yield and book-to-market ratio are both stationary, and empirical evidence for this is, at best, mixed. We develop a new model, the loglinear cointegration model, that explains future profitability and excess stock returns in terms of a linear combination of log book-to-market ratio and log dividend yield. The loglinear cointegration model performs better than the log dividend yield model and the log book-to-market model in terms of cross-equation restriction tests and forecasting performance comparisons. The superior performance of the loglinear cointegration model suggests that the linear combination may be a better indicator of intrinsic fundamentals than the dividend yield or the book-to-market ratio separately.

Original Publication Date

2-1-2007

DOI of published version

10.1016/j.jbankfin.2006.07.012

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