Non-linear cointegration between stock prices and dividends

Abstract

This article uses the ACE algorithm to non-linearly transform stock prices and dividends for the USA for the period 1871–1999. It finds strong evidence of cointegration between the transformed variables, which can be characterized as non-linear cointegration. It concludes that departures from the linear present value model may be explained by misspecification of the model, which is attributed to the absence of appropriate nonlinear transformations of the variables. Our findings are in line with models that introduce nonlinearities in the relation between stock prices and dividends.