The Persistence and Predictive Power of the Dividend-Price Ratio

This paper presents strong statistical evidence that the dividend- price ratio in the US has experienced a change in persistence from I(0) to I(1), while stock returns have not. This provides an econometric explanation why the predictive power of the dividend-price ratio in the US has changed drastically. When the dividend-price ratio is I(0), it can have predictive power for future stock returns by the force of the cointegration relation between dividends and stock prices. However, if the dividend-price ratio becomes I(1), then it should have no predictive power for stock returns which have not experienced a change in persistence and are well known to be I(0). This relation between the persistence and the predictive power of the dividend-price ratio is well observed not only in the US but also in Japan, although the underlying causes and directions of the change in persistence appear different in the two countries.