Essays on A Rational Expectations Model of Dividend Policy and Stock Returns
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We propose an asset pricing model in a production economy where cash flows are determined by firms' optimal dividend and investment decisions. Extensive and intensive decision margins in dividend payout are modeled with cash holding and investment adjustment costs. The model implies that delays in dividend distribution of young and growing firms play instrumental roles in explaining various asset pricing anomalies. Quantitative results show that model-implied dividend policies and investments are consistent with data, and the cross sections of stock returns are well explained by the interactions between productivity shocks and the lumpy dividend policies. Additionally, the model produces countercyclical variations in the market risk premium. In addition, we empirically investigate the relevance of firm characteristics and aggregate productivity shocks in determining dividend payment propensity, thereby asset prices. It is found that excess returns for dividend payers over nonpayers are significantly linked to business cycles. Relative future returns are fairly predicted by the spread of lagged propensities to pay dividends. Furthermore, the empirical results document that each future return of payers and nonpayers increases in propensities to pay out cash to shareholders. These results are consistent to our rational expectations model of dividend policy, and contradictory to the catering theory of dividends.