The Predictive Power of the Dividend Risk Premium

We show that the dividend growth rate implied by the options market is informative about i) the expected dividend growth rate and ii) the expected dividend risk premium. We model the expected dividend risk premium and explore its implications for the predictability of dividend growth and stock market returns. Correcting for the expected dividend risk premium strengthens the evidence for the predictability of dividend growth and stock market returns both in and out of sample. Economically, a market-timing investor who accounts for the time-varying expected dividend risk premium realizes an additional utility gain of 2.02% per year.