Implied Dividends and Equity Returns

This paper studies the option market?s implied dividend as a predictor of future equity market returns. We introduce this variable in the simple total return framework and discuss some complications of using it as a proxy for the expected dividend. We construct some regressions using the price-dividend ratio and the implied dividend growth, and test them on six years worth of data on the EURO STOXX 50-index. The main result is that implied dividend growth exhibits some forecastability over two-year horizons, but that the dataset is too short to draw any definitive conclusions about long-horizon forecastability. We also find that traditional proxies of risk premium (volatility risk premium, credit spreads and interest rate term-spread) improve the explanatory power of implied dividend growth, and that they have very high explanatory power themselves.


1. Introduction
2. Prior Research
3. Theoretical Background
Implied Dividends
Dividends and Returns
4. Method and Data
5. Results
Implied and Realized Dividends
Dynamics of the Price-Dividend Series
Main Regression – Return Prediction Using Implied Dividends
Adding Risk Premium
6. Conclusion
7. References
8. Appendix


Source: Stockholm School of Economics

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