Dividend Dynamics, Learning, and Expected Stock Index Returns

We develop a model for dividend dynamics and allow investors to learn about model parameters over time. The model predicts 31.3% of the variation in annual dividend growth rates during 1976-2013. We show that when investors' beliefs about the persistence of dividend growth rates increase, dividend-to-price ratios increase, and short-horizon stock returns decrease after controlling for dividend-to-price ratios. These findings support investors' preferences for early resolution of uncertainty. We embed learning about dividend dynamics into an equilibrium asset pricing model. The model predicts 22.9% of the variation in annual stock returns. Learning accounts for over forty-percent of the 22.9%.