DIVIDEND VARIABILITY AND STOCK-MARKET SWINGS

This paper examines the extent to which swings in stock prices can be related to variations in the discounted value of expected future divid ends when investors face uncertainty about their future behaviour. I d evelop an econometric model that accounts for the instability of U.S. dividend growth and discount rates during the past 120 years. Estimate s of the model reveal that changing forecasts of future dividend growt h account for more than 90% of the predictable variations in dividend- prices. The estimates also imply that instability in the dividend and discount rate processes contribute significantly to the predictability of long-horizon stock returns.