MODELING THE DIVIDEND-PRICE RATIO: THE ROLE OF FUNDAMENTALS USING A REGIME-SWITCHING APPROACH

Using annual data over the post-World War I-period, we estimate a fundamentals-based <p> empirical model for the dividend-price ratio of Danish stocks. The key fundamentals-variable <p> is a time-varying discount rate, decomposed into time-varying measures for the growth-adjusted <p> real interest rate and the risk premium on stocks. In addition, the model includes <p> real dividends and the lagged dividend-price ratio as explanatory variables. Results show <p> that the model suffers from structural breaks over the sample. Using a two-state regime-switching <p> approach to capture non-modeled shifts in the economic environment, we find that <p> all fundamentals are highly significant in at least one regime and, moreover, obtain a good <p> fit. The model identifies two very persistent regimes characterized by a ‘low’, respectively, <p> ‘high’ dividend-price ratio.