Newsletter: The Predictive Power of Dividend Yield in Equity Markets

How Dividend Yield Impacts Stock Volatility and Future Returns

Dividend yield has long been a cornerstone of equity valuation. In this issue, we explore how dividend yield predicts stock returns, its impact on stock volatility, and why it holds unique significance for mature, dividend-paying firms.

Web-only posts Recap

Below is a summary of the web-only posts I published during last week

Blending Low-Volatility with Momentum Anomalies

Volatility Risk Premium Is a Reward for Bearing Overnight Risk

Enhancing Volatility Portfolio Returns with VRP Timing

Examining ITM Options Among Retail and Professional Traders

Does the Fed Put Really Exist?

Does Trend Following Still Work on Single-Name Stocks? Updated Results

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Relationship Between Implied Volatility and Dividend Yield

Reference [1] explores the relationship between implied volatility (IV) and dividend yield. It investigates how the dividend yield impacts the implied volatility. The study supports the bird-in-hand theory rather than the dividend irrelevance theory. Results show that there exists a negative relationship between dividend yield and IV, and this relationship is stronger for puts than calls.

Findings

- This thesis examines the link between implied volatility and dividend yield in the options market, comparing the Bird-in-Hand theory and the Dividend Irrelevancy theory.

- Results show that dividend yield significantly impacts implied volatility, with a stronger and consistent negative relationship observed in put options, aligning with the Bird-in-Hand theory.

- The relationship in put options suggests a stronger and more consistent impact of dividend yield, aligning with the Bird-in-hand theory.

- The findings support the hypothesis that an increase in a firm's dividend yield tends to decrease future volatility.

- This effect was particularly pronounced in put option models but also observed in call option models.

- The study emphasizes the need for alternative methodologies, larger sample sizes, and additional variables to deepen the understanding of option pricing dynamics.

Reference

[1] Jonathan Nestenborg, Gustav Sjöberg, Option Implied Volatility and Dividend Yields, Linnaeus University, 2024

The Impact of Dividend Yield on Stock Performance

Dividend yield is a reliable predictor of future stock returns, particularly during periods of heightened volatility. This article [2] explores the connection between dividend yield, stock volatility, and expected returns.

Findings

- This study shows that dividend yield predicts returns for dividend-paying firms more effectively than alternative pricing factors, challenging previous research.

- Using the most recent declaration date to calculate dividend yield significantly improves return predictability compared to using the trailing yield.

- Asset pricing strategies tend to underperform within mature, profitable firms that pay dividends, highlighting a unique pattern.

- Cross-sectional tests suggest dividend yield predicts returns because investors value receiving dividends rather than as an indicator of future earnings.

- Dividend yield is concluded to be a valuable valuation metric for mature, easier-to-value firms that typically pay dividends.

- Volatility, measured as the trailing twelve-month average of monthly high and low prices, impacts return predictability.

- Excessively volatile prices drive predictability, with dividend yield strategies generating around 1.5% per month.

- During heightened volatility periods, dividend yield strategies yield significant returns.

- Cross-sectionally, dividend yield is a more accurate predictor for returns in volatile firms.

Reference:

[2] Ahn, Seong Jin and Ham, Charles and Kaplan, Zachary and Milbourn, Todd T., Volatility, dividend yield and stock returns (2023). SSRN

Closing Thoughts

Dividend yield is shown to be a useful valuation metric, particularly for mature and easily valued firms that consistently pay dividends. Furthermore, the research emphasizes that investors prioritize the receipt of dividends over their informational value regarding future earnings. These insights reaffirm the importance of dividend yield in understanding market dynamics and developing effective investment strategies.

Educational Podcast

Estimating Long-Term Expected Returns

In this podcast episode, the Quantopian team talks about the science of predicting long-term equity returns. They discuss key frameworks like dividend yield, the Gordon growth model, valuation metrics, and an innovative three-component approach. Learn how these strategies can help you make informed investment decisions, enhance returns, and reduce risk.

Around the Quantosphere

- Robert Whaley Selected as the Recipient of the 2024 IAQF/Northfield Financial Engineer of the Year Award (prweb)

- Jean-Philippe Bouchaud - Quant Researcher of the Year 2024 (pm-research)

- Podcast: Navigating the hedge fund frontier, Insights from CPP Investments (jpmorgan)

- Billionaire Alex Gerko’s XTX to Build €1 Billion Data Hub in Machine-Learning Bet (Yahoo finance, Bloomberg)

Recent Newsletters

Below is a summary of the weekly newsletters I sent out recently

-Monte Carlo Simulations: Pricing Weather Derivatives and Convertible Bonds (8 min)

-PCA in Action, From Commodity Derivatives to Dispersion Trading (8 min)

-CAPM, WACC, and Beyond: Beta’s Application in Arbitrage (8 min)

-Wrapping Up 2024-Crypto Trading Strategy and Money Laundering Threats (6 min)

Disclaimer

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