The dog that did not bark: A defense of return predictability

Abstract

If returns are not predictable, dividend growth must be predictable, to generate the observed variation in divided yields. I find that the absence of dividend growth predictability gives stronger evidence than does the presence of return predictability. Long-horizon return forecasts give the same strong evidence. These tests exploit the negative correlation of return forecasts with dividend-yield autocorrelation across samples, together with sensible upper bounds on dividend-yield autocorrelation, to deliver more powerful statistics. I reconcile my findings with the literature that finds poor power in long-horizon return forecasts, and with the literature that notes the poor out-of-sample R2 of return-forecasting regressions. © The Author 2007. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved.