Inflation illusion and the dividend yield: evidence from the UK

We report evidence that the UK dividend yield and expected inflation are positively correlated from 1962 to 1997, but negatively correlated subsequently. Using a commonly used VAR (vector auto-regression)-based procedure we find strong evidence that the positive correlation is caused both by inflati...

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Bibliographic Details
Published in:The European journal of finance 2014-12, Vol.20 (12), p.1230-1245
Main Authors: Acker, Daniella, Duck, Nigel
Format: Article
Language:English
Subjects:
Correlation
Correlation analysis
dividend yield
Dividends
Financial analysis
Financial reforms
Inflation
inflation illusion
Rates of return
Rationality
Regression analysis
Studies
United Kingdom
Vector-autoregressive models
Yield
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Summary:We report evidence that the UK dividend yield and expected inflation are positively correlated from 1962 to 1997, but negatively correlated subsequently. Using a commonly used VAR (vector auto-regression)-based procedure we find strong evidence that the positive correlation is caused both by inflation illusion and the effect of inflation on required rates of return. We also find some evidence that it is caused by inflation rationally reducing expected real dividend growth. We find that Chen and Zhao's (2009. "Return Decomposition." Review of Financial Studies 22 (12): 5213-5249) criticism of the VAR-based procedure has little empirical relevance but that the procedure can be highly sensitive to the choice of data period.
ISSN:1351-847X
1466-4364
DOI:10.1080/1351847X.2013.784207