[This article investigates the hypothesis that dividend changes are determined by changes in some measure of permanent earnings. The analysis employs two measures of permanent earnings and takes into account the nonstationarity of dividend and earnings series. This study finds that dynamic dividend behavior is accounted for primarily by changes in permanent earnings. Dividends respond strongly to permanent changes in earnings without any significant overreaction, whereas they respond little, if at all, to transitory changes in earnings. The findings also suggest that the partial adjustment hypothesis, which assumes managers partially adjust dividends to a target dividend, performs better when the target dividend level is proportional to permanent earnings than when it is proportional to current earnings.]

Several hypotheses have been proposed to explain the stock return–inflation relation. The Modigliani and Cohn’s inflation illusion hypothesis has received renewed attention. Another hypothesis is the two-regime hypothesis. We reexamine these hypotheses using long sample data of the US and international data. We find that the inflation illusion hypothesis can explain the post-war negative stock return–inflation relation, but it is not compatible with the pre-war positive relation. Using a structural VAR identification method, we show that there are two regimes with positive and negative stock return–inflation relations not only in each period of the US but also in every developed country we consider. This seems inconsistent with the inflation illusion hypothesis that predicts only a negative relation.

Using a multivariate vector-autoregression approach, this paper investigates causal relations and dynamic interactions among asset returns, real activity, and inflation in the postwar United States. Major findings are (1) stock returns appear Granger-causally prior and help explain real activity; (2) with interest rates in the vector autoregression, stock returns explain little variation in inflation, although interest rates explain a substantial fraction of the variation in inflation; and (3) inflation explains little variation in real activity.

In this paper we study the dynamic nature of the relationship between earnings and investment. If managers act as wealth maximizers, we would expect that new investments should lead to increased earnings. However, past research has found that investment is not causally prior to earnings. Using recent developments in time-series econometrics, we show that the dynamic nature of the relationship between earnings and investment exhibits bi-directional causality. Our results are consistent with managers investing in positive NPV projects, but managers appear to face financing constraints because investment decisions are driven by the availability of internally generated earnings.

[We account for the relation between stock returns and inflation with two independent disturbances: supply shocks and demand shocks. Supply shocks reflect real output shocks and cause a negative relation between stock returns and inflation, while demand shocks are mainly due to monetary shocks and generate a positive relation between stock returns and inflation. We show, both theoretically and empirically, that the stock return-inflation relation varies over time and across countries, depending on the relative importance of the two types of shocks. Our empirical evidence is based on pre- and postwar periods in the United States, as well as the postwar period in the United Kingdom, Japan, and Germany.]

This paper identifies various components of stock prices and examines the response of stock prices to different types of shocks: permanent and temporary changes in earnings and dividends, changes in discount factors, and non-fundamental factors. The analysis is conducted in a log-linear structural VAR framework. I find that about half of the yearly variation in prices is not related to either earnings or dividend changes. Time-varying interest rates do not help explain the remaining price movements. However, time-varying excess stock returns (i.e., risk premiums) account for much of the remaining variation in stock prices, in particular, in the postwar period. As a result, the deviation of stock prices from these fundamentals reduces to about 10% of stock price movements and tends to persist for a while before it declines eventually. This finding seems more compatible with a fad rather than a bubble interpretation.

This paper investigates the response of stock prices to dividend shocks in a bivariate model of stock prices and price-dividend spreads. Dividend process is modeled as the sum of a permanent component and a temporary component. By using the stock price valuation (present value) model, the two components are related to stock prices. The stock market responds significantly not only to permanent shocks to dividends, but also to temporary shocks to dividends. Furthermore, initial responses of stock prices to the temporary shocks are as strong as those to the permanent shocks. As a result, substantial variation in stock prices is due to the temporary shocks. This finding provides empirical support for the imperfect information hypothesis that emphasizes the failure of investors to clearly dis? tinguish between the two components of dividends, and also suggests that the observed mean-reverting behavior of stock returns should be explained by incorporating a significant temporary component into stock prices. The price-dividend spreads are primarily accounted for by the temporary shocks to dividends, and respond strongly to them, suggesting that, in response to the temporary shocks to dividends, stock prices respond excessively relative to dividends.

This article investigates the hypothesis that dividend changes are determined by changes in some measure of permanent earnings. The analysis employs two measures of permanent earnings and takes into account the nonstationarity of dividend and earnings series. This study finds that dynamic dividend behavior is accounted for primarily by changes in permanent earnings. dividends respond strongly to permanent changes in earnings without any significant overreaction, whereas they respond little, if at all, to transitory changes in earnings. The findings also suggest that the partial adjustment hypothesis, which assumes managers partially adjust dividends to a target dividend, performs better when the target dividend level is proportional to permanent earnings than when it is proportional to current earnings.

This paper discusses a method of deriving the univariate ARIMA process followed by a time series of rational forecasts y(superscript "e") of a series y, given the ARIMA process followed by y. The method suggests examination of the empirical ARIMA process followed by y(superscript "e") as a test of the hypothesis that y(superscript "e") is a rational forecast of y in a strong sense. The method is applied to a measure of expected inflation: the survey data conducted by Money Market Service, Inc., of money market participants.

The effect of diversification on firm performance has been debated. We reexamine the effect using a sample of 44,248 observations of non-financial US firms for the 1997–2009 period employing the quantile regression approach. Our empirical results show that the effect of diversification on firm performance is not homogeneous across various quantile levels: the diversification discount (premium) shows up in firms with high (low) RoE quantiles. Further, we find that diversification affects firm risk as well. Therefore, we consider a risk-adjusted performance measure and find that both diversification discount and premium disappear, which is consistent with the risk-return trade-off principle.