Juan Antolín-Díaz, Ivan Petrella, and Juan Rubio-Ramírez
Working Paper 2021-25
November 2021
Abstract: A long tradition in macro finance studies the joint dynamics of aggregate stock returns and dividends using vector autoregressions (VARs), imposing the cross-equation restrictions implied by the Campbell-Shiller (CS) identity to sharpen inference. We take a Bayesian perspective and develop methods to draw from any posterior distribution of a VAR that encodes a priori skepticism about large amounts of return predictability while imposing the CS restrictions. In doing so, we show how a common empirical practice of omitting dividend growth from the system amounts to imposing the extra restriction that dividend growth is not persistent. We highlight that persistence in dividend growth induces a previously overlooked channel for return predictability, which we label "dividend momentum." Compared to estimation based on ordinary least squares, our restricted informative prior leads to a much more moderate, but still significant, degree of return predictability, with forecasts that are helpful out of sample and realistic asset allocation prescriptions with Sharpe ratios that outperform common benchmarks.
JEL classification: C32, C53, G11, G12, E47
Key words: CS restrictions, Bayesian VAR, optimal allocation
https://doi.org/10.29338/wp2021-25
The authors are grateful to Svetlana Bryzgalova, John H. Cochrane, Francisco Francisco Gomes, Hélène Rey, Vania Stavrakeva, and seminar participants at the Federal Reserve Bank of Atlanta, the University of Pennsylvania, the London Business School, and Warwick Business School for helpful comments and suggestions. The views expressed here are those of the authors and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the authors' responsibility.
Please address questions regarding content to Juan F. Rubio-Ramírez, Economics Department, Emory University, Rich Memorial Building, Room 306, Atlanta, GA 30322-2240, juan.rubio-ramirez@emory.edu.
To receive e-mail notifications about new papers, subscribe. Under "Publications" select "Working Papers."