The Predictive Power of the Dividend Risk Premium

Abstract

We show that the dividend growth rate implied by the options market is informative about (i) the expected dividend growth rate and (ii) the expected dividend risk premium. We model the expected dividend risk premium and explore its implications for the predictability of dividend growth and stock market returns. Correcting for the expected dividend risk premium strengthens the evidence of dividend growth and stock market return predictability both in-and out-of-sample. Economically, a market timing investor who accounts for the time varying expected dividend risk premium realizes an additional utility gain of 2.02 % per year.

Investor sentiment, misreaction, and the skewness‐return relationship

“…In addition, the reveals the information regarding future dividend growth and real economic activity. For instance, Golez (2014) and Avino et al (2019) show that the implied dividend growth rate, which is associated with the price difference between put and call options, predicts future dividend growth. Their results provide evidence of a link between and future dividend growth.…”

“… is the dividend growth rate implicit in the relative price difference between puts and calls and is a reliable predictor of future dividend growth rates. Following an approach similar to Avino et al (2019), we extract the from stock index options based on the PCP relationship. We use the to control for the influence of the implied dividend growth on the .…”

“…Existing literature shows that the contains information on informed trading, short‐sales constraints on the underlying stocks, nonsynchronous trades, transaction costs, margin requirements, and the early exercise value of American options (Atilgan, 2014; Battalio & Schultz, 2006; Bollerslev et al, 2009; Chan et al, 2015; Cremers & Weinbaum, 2010; Easley et al, 1998; Finucane, 1991; Klemkosky & Resnik, 1980; Lamont & Thaler, 2003; Liu & Longstaff, 2000; Nisbet, 1992; Ofek & Richardson, 2003; Ofek et al, 2004; Shleifer & Vishny, 1997; Xing et al, 2010). Information regarding implied dividend growth (Avino et al, 2019; Golez, 2014) and real economic activity (Han & Li, 2020) are also embedded in the . In consequence, we adopt an adjustment regression to abstract the information about misreaction from the put‐call implied by removing some relevant factors affecting the .…”