19 November 2009
“Demographic Trends, Low Frequency Fluctuations in the Aggregate Dividend/Price Ratio and the Predictability of Long-Run Stock Market Returns”
by Carlo Favero (Bocconi University)
19 November 2009, h 12:00, Sala Rossa
We analyze aggregate long-run stock market return predictability within the dynamic dividend growth model. The crucial assumption of the model for long-run predictability is that of stationarity of the log dividend price ratio. The validity of this assumption has been challenged in the recent literature and its failure has been highlighted as a potential explanation for the mixed evidence on the forecasting performance of the model. We document the existence of a slowly evolving trend in the mean dividend/price determined by demographic variables. Deviations from this slowly evolving long-run component explain transitory (business cycle) movements of aggregate excess stock market returns and increase their out-of-sample predictability. On the basis of this evidence, we exploit the exogeneity and predictability of the demographic variables to simulate the equity risk premium up to 2050.
Keywords: error correction model, long run predictability, equity premium, cointegration, demographics.
JEL Classification Numbers: G14, G19, C10, C11, C22,C53.
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