Stock Returns, Dividend Yield, And Book-To-Market Ratio
Book-to-market ratio, Cointegration, Dividend yield, Present value model
Journal of Banking and Finance
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.
Department of Finance
Original Publication Date
DOI of published version
Jiang, Xiaoquan and Lee, Bong Soo, "Stock Returns, Dividend Yield, And Book-To-Market Ratio" (2007). Faculty Publications. 2651.