Threshold cointegration and nonlinear adjustment between stock prices and dividends

Abstract

According to several empirical studies, the linear present-value model fails to explain the behaviour of stock prices in the long run. We analyse the possible presence of threshold cointegration between real stock prices and dividends for the US market during the period from 1871:1 to 2004:6. According to our results, the null hypothesis of linear cointegration between stock prices and dividends is rejected in favour of a two-regime threshold cointegration model. We find also that stock prices do not respond to equilibrium error, and dividends respond to the past divergence only if the deviation from the equilibrium error does not exceed the estimated threshold parameter. This in turn would support theoretical models assuming that the stock price–dividend relation is nonlinear.

Acknowledgements

V. Esteve wants to acknowledge the financial support of the project SEJ2005-01163 (Spanish Ministry of Education and Science) and the project PAI07–0021-5148 (Department of Education and Science of Castilla-La Mancha's Government). M. Prats wants to acknowledge the financial support of the project SEJ2006-05051 (Spanish Ministry of Education and Science).

Notes

¹ Real stock prices and dividends series were expressed in natural logaritms. The lowercase letters denote the logs of the variables.

² We found evidence that real stock prices and real dividends series are nonstationary variables. The results are available upon request.