Return and Dividend Expectations in the Cross-Section of Prices

I build a price-ratio model based on the Campbell and Shiller (1988) decomposition to test which components of investor expectations best explains cross-sectional price differences. I evaluate the in- and out-of-sample performance of my model, which uses a higher-order expansion with an added variance term. In-sample, I find differences in price-ratios are most attributable to cash-flows, not returns. Out-of-sample, the CS model struggles with individual firms but works well for characteristic-sorted portfolios where information in the cross-section can be used to generate out-of-sample predictions. Finally, I decompose the model’s missed variation and find that firms with high levels of institutional ownership or operating profitability are not well explained in this auto-regressive framework