Dividends, Momentum, and Macroeconomic Variables as Determinants of the US Equity Premium Across Economic Regimes

Abstract

The equity premium of the S&P 500 Index is explained in this paper by several variables that can be grouped into fundamental, behavioral and macroeconomic factors. We hypothesize that the statistical significance of these variables changes across economic regimes. The three regimes we consider are the low, medium and high volatility regimes in contrast to previous studies that do not differentiate across economic regimes. Using the three-state Markov switching regime econometric methodology we confirm that the statistical significance of the independent variables representing fundamentals, macroeconomic conditions and a behavioral variable changes across economic regimes. Our findings offer an improved understanding of what moves the equity premium across economic regimes than what we can learn from single-equation estimation. Our results also confirm the significance of momentum as a behavioral variable across all economic regimes.Key Words: Excess stock returns, equity premium, dividends, macroeconomic variables, momentum, Markov regimes. JEL Classification: C22, E44, G12Current Revised Version: February10, 2011. The authors are very grateful to Professor Ravi Jagannathan for a detailed review of an earlier version of this paper that contributed to a substantial improvement of our hypotheses formulation and econometric methodology. We are also thankful to Professor John Doukas for insightful clarifications on the selection of the appropriate behavioral variable. The presentation of this paper in various seminars in the U.S. and Australia has encouraged the authors enrich both the methodology and exposition of the paper. A detailed and constructive referee report has helped the authors to refocus the scope of this research and to enrich the presentation. Special thanks are offered to the anonymous referee and the editor of the Review of Behavioral Finance. Resubmitted to the REVIEW OF BEHAVIORAL FINANCE. This is the latest master copy dated March 25, 2011.This article is Emerald Publishing Limited and permission has been granted for this version to appear in Loyola eCommons. Emerald does not grant permission for this article to be further copied/distributed or hosted elsewhere without the express permission from Emerald Publishing Limited. 2 Dividends, Momentum and Macroeconomic Variables as Determinants of the U.S. Equity Premium Across Economic Regimes AbstractThe equity premium of the S&P 500 Index is explained in this paper by several variables that can be grouped into fundamental, behavioral and macroeconomic factors. We hypothesize that the statistical significance of these variables changes across economic regimes. The three regimes we consider are the low, medium and high volatility regimes in contrast to previous studies that do not differentiate across economic regimes. Using the three-state Markov switching regime econometric methodology we confirm that the statistical significance of the independent variables representing fundamentals, macroeconomic conditions and a behavioral variable chang...

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