Demographic Trends, the Dividend-Price Ratio, and the Predictability of Long-Run Stock Market Returns

This paper documents the existence of a slowly evolving trend in the log dividend-price ratio, DP<italic>null</italic>, determined by a demographic variable, MY<italic>null</italic>: the middle-aged to young ratio. Deviations of DP<italic>null</italic> from this long-run component explain transitory but persistent fluctuations in stock market returns. The relation between MY<italic>null</italic> and DP<italic>null</italic> is a prediction of an overlapping generation model. The joint significance of MY and DP<italic>null</italic> in long-horizon forecasting regressions for market returns explains the mixed evidence on the ability of DP<italic>null</italic> to predict stock returns and provide a model-based interpretation of statistical corrections for breaks in the mean of this financial ratio.