The Spread between the Bond Yield and the Dividend Yield and the Dividend Premium

Abstract

Empirical tests of the catering theory of dividends find that payout policy is influenced by the dividend premium, the relative market valuations of dividend paying versus non-paying firms. This paper offers the yield spread hypothesis of the dividend premium: investors tend to place lower valuations on dividend paying stocks when their yield is relatively low compared to risk-free bonds. After controlling for other variables that may affect the dividend premium, I find the spread between the one-year US Treasury note and the S&P 500 dividend yield is significantly and inversely associated with the dividend premium. The results are consistent with investors that have regular cash distribution preferences comparing yields on competing financial instruments.

Key Words: Dividend premium, Payout policy, Bond yield, Dividend yield

I. Introduction

Miller and Modigliani’s (1961) theoretical paper on dividends led them to their famous

proposition that dividend policy does not affect firm value. They arrived at their conclusion by assuming

perfect capital markets and a fixed corporate investment plan. These restrictions are not representative

of the real environment in which investors and firms operate. Relaxing them to gain insight into the

dividend policy choices of managers has been the focus of much subsequent research.

One recent theory of dividend policy is the catering model proposed by Baker and Wurgler

(2004), from now on “BW”. BW relaxes Miller and Modigliani’s (1961) assumption that stocks are always

priced efficiently. They theorize that investor demand for dividend-paying stocks varies through time

and can result in the mispricing of firms that pay dividends versus those that do not. The valuation

discrepancies can persist because of structural inefficiencies in the financial markets.1 BW call this

valuation differential the “dividend premium”, which is calculated as the natural log of the ratio of

average market-to-book values of payers and non-payers.2 BW hypothesize that managers know when

their firms are mispriced along this dimension and make dividend policy decisions accordingly to

maximize shareholder value. For example, BW predict that when investors place a relatively high

valuation on firms that pay dividends, managers will be more likely to initiate a dividend.

The empirical evidence supports the catering theory. BW show that changes in the dividend

premium explain 60% of the annual variation in dividend initiations over a forty year sample period. Li

and Lie (2006) apply the catering theory to a sample of dividend increases and decreases (as opposed to

BW’s initiation and omission sample) and show that variation in the dividend premium is a significant

1 For example, Miller (1977) explains how restrictions on the use of funds from short sales can lead to continuing discordance in equity prices that arise from divergent opinions.2 The other proxies Baker and Wurgler (2004) use for the dividend premium are “the difference in the prices of Citizens Utilities’ (CU) cash dividend and stock dividend share classes (between 1956 and 1989 CU had two classes of shares which differed in the form but not the level of their payouts); the average announcement effect of recent dividend initiations; and the difference between the future stock returns of payers and nonpayers.”

determinant of these more frequent, ongoing payout policy decisions. Bulan et al. (2007) find that the

dividend premium is a strong predictor of dividend initiations and Ferris et al. (2006) provide

international evidence in favor of the catering theory of dividend policy.

Despite these empirical findings, Lee (2011) notes that there has been little written on the

factors that influence the dividend premium.3 This paper seeks to fill this gap in the literature and

proposes that the dividend premium is associated with the spread between the yield on the one-year

Treasury note and the S&P 500 dividend yield. I assume that there are classes of investors that prefer

equity securities that distribute cash at regular intervals.4 Firms that pay dividends tend do so at regular

intervals and rarely reduce them.5 These two features make dividends a viable substitute to interest

payments from debt securities. There have been numerous stories in the financial press discussing this

tradeoff between low interest rates and dividend yields during the low interest rate environment of

2008-2014.6

While the relative risks of bonds and stocks are generally different, the fixed-income market and

dividend paying stocks form part of an investment opportunity set for investors seeking securities with

cash distributions. I hypothesize that when bond securities offer relatively low yields, investors seek

current income from alternative investments, such as dividend-paying stocks. These dividend-paying

stocks may receive higher valuations from this increased demand which would be reflected in a higher

dividend premium. Alternatively, when the yield on bond securities is high relative to the dividend yield,

I predict the dividend premium will be relatively low as investors have an attractive alternative to satisfy

their demand for periodic cash proceeds.

3 A review of these few studies appears in the next section of this paper.4 See Miller and Modigliani (1961), Thaler and Shefrin (1981), Shefrin and Statman (1984), and Shefrin and Thaler (1988) for theoretical reasons on why dividend clienteles may exist.5 For example, see survey evidence in Brav et al. (2005).6 For example, see http://www.marketwatch.com/story/time-to-dump-high-dividend-stocks-2014-04-08 and http://www.fool.com/investing/beginning/2013/11/10/the-biggest-reason-stocks-are-at-record-highs.aspx

The evidence is this paper broadly supports the yield spread hypothesis: after controlling for

other variables that may affect the dividend premium, such as investor sentiment, age variation in the

population, agency costs, tax differentials, business cycle fluctuations, and profitability, the spread

variable is significantly and inversely associated with the dividend premium. I also show that the spread

between a portfolio of Moody’s Baa-rated corporate bonds and the dividend yield, which is more likely

to reflect investor sentiment and the risk premium, is generally not associated with the dividend

premium in the main multivariate framework. These results are consistent with investors placing a

premium valuation on dividend paying stocks when their yield is comparatively high compared to

default risk-free bond yields and vice versa.

This paper contributes to the existing literature on dividend policy in several ways. First, I offer a

new factor that helps explain the variation in the dividend premium, the force behind the catering

theory of dividend policy. This bond yield-dividend yield spread variable is robust to a number of

specifications. Despite all of the attention on dividends over the past fifty years, I am not aware of any

study that has directly postulated that the competing yields on fixed income products can have an

impact on a firm’s dividend policy decisions.7 The omission of fixed-income yield variables in the extant

dividend premium models is somewhat surprising because the tradeoff between debt and equity yields

is a reasonable conjecture on what affects the demand for dividend-paying stocks.

Second, the theoretical underpinnings of the yield spread hypothesis are more comprehensive

than the demographic theory of the dividend premium put forth by Lee (2011). He makes a convincing

argument that changes in the age structure of the population drives movements in the dividend

premium. However, an age-based explanation cannot account for why investors would prefer dividend-

7 Lee (2013) cites a passage in a Dividend Stocks for Dummies book as the rationale for including interest rate variables as controls in his study of the effect of demographics on the long-term returns to dividend-yield based investment strategies. However, that study does not deal with the explaining the dividend premium (which in turn explains managerial behavior), which is the focus of this paper.

paying equities when risk-free securities offer high yields, nor does it account for the risk-averse

preferences of investors that do not fit a particular age profile. My empirical analysis shows that the

significance of the age structure variable is subsumed by the spread variable.

Third, my empirical tests are somewhat more powerful than previous studies on the dividend

premium. For example, annual data on the age structure of the population are estimates based on

census data which is officially measured only once every decade. On the other hand, spreads between

bond and dividend yields can be measured more precisely and monthly, providing a sample size that is

ten-times as large as prior studies on the dividend premium.

II. Literature Review

A. Why dividends?

Why might investors demand dividends in the first place?8 Miller and Modigliani (1961) argue

that dividend policy is irrelevant to firm valuation because investors can create homemade dividends by

selling shares to generate income. In a world with taxes, such a strategy would be efficient if the tax rate

on capital gains is less than the tax rate on dividends, as is often the case. However, Black (1976) notes

the preference for a cash dividend by some investors is undeniable. He briefly reviews many mainstream

reasons why dividends may be preferred (or not preferred) and debunks them all leaving us with his

famous “dividend puzzle”. Potential explanations for why dividends exist largely relate to market

inefficiencies, tax policy, information asymmetry, and agency costs.9

Behavioral theorists also offer alternative explanations of the preference of dividend payments

even in the absence of market frictions. For example, Shefrin and Statman (1984) use Thaler and

Shefrin’s (1981) self-control framework and argue that investors with difficulties controlling their will

8 For an easy to read, more detailed recent review of dividend theories see Al-Malkawi et al. (2010).9 See Asquith and Mullins (1983) for how dividends can act as signals of future performance and Jensen (1986) for how dividends can reduce agency costs.

power may prefer dividends to selling shares themselves in order to avoid the temptation of reducing

the principal invested too quickly. Shefrin and Statman (1984) also argue that investors who are averse

to regret will prefer to finance current consumption out of dividends lest they miss out on the potential

future capital appreciation of shares they sold. Regardless of the source of investor demand for

dividends, I assume that there are at least some investors that prefer stocks that pay dividends. This

assumption is broadly consistent with the empirical evidence on dividends.10

B. The Dividend Premium

BW attributes the link between the dividend premium and dividend decisions to managers

rationally catering to their shareholders by exploiting market mispricing. They arrived at this conclusion

in several steps. First, they systematically eliminate explanations related to time-variation in firm

characteristics, such as growth opportunities, and agency costs because these reasons were inconsistent

with their full set of results. BW then asks “Who are managers catering to?” BW show that managers do

not appear to be catering to clienteles based on tax concerns, transactions costs, and institutional

investment constraints. This corresponds with survey evidence from Brav et al. (2005) that suggests that

managers do not consider the demands of clienteles of any sort. On the other hand, BW provides

evidence that managers cater to investor sentiment: the dividend premium is positively correlated with

the closed-end fund discount.11 A large closed-end fund discount is associated with poor investor

sentiment. When the discount is large, investors may drive up the relative valuation of dividend payers

versus non-payers if they perceive the former as safer investments. While investor sentiment appears to

play a pivotal role, BW admit that unresolved issues with what the closed-end fund discount truly

measures detracts from its theoretical link with the dividend premium.

10 While Fama and French (2001) show that the number of firms paying dividends has declined dramatically through time, Deangelo et al. (2004) show that the total dollar value of dividends paid has increased through time.11 Zweig (1973) introduced the closed-end fund discount, the amount by which the price of the fund is below its net asset value, as a proxy for investor sentiment.

Other studies that have attempted to identify variables that affect the dividend premium have

yielded mixed results. Liu and Shan (2007) tied changes in the dividend premium to proxies for agency

costs and signaling motives, but Lee (2011) points out their results were not robust when a simple time

trend was added to the model. In the most promising recent research, Lee (2011) finds that the dividend

premium is positively correlated with demographic variation as measured by annual changes in the

proportion of persons aged above 65 to those aged under 45.12 His result is consistent with other

research pertaining to dividend policy and demographics. For example, Becker et al. (2011) show that

firms headquartered in areas in which seniors make up a large percentage of the population are more

likely to initiate a dividend. Additionally, Graham and Kumar (2006) investigated retail investor stock

trading behavior and found that older investors tend to buy stocks after dividend announcements and

just before the ex-dividend date.

III. Hypothesis Development

A. Motivation

The demographic theory of the dividend premium put forth by Lee (2011) can be summarized as

follows. Older investors tend to concentrate their portfolios in income generating investments when

they turn 65 years old. The lack of labor income in this demographic could be an impetus that drives

these investors to equity securities that offer income. Time variation in the older-to-younger ratio can

impact the relative valuation difference between dividend payers and non-payers.13 Specifically, as the

ratio of older-to-younger persons in the economy increases compared to the prior year, dividend payers

receive a premium valuation compared to non-payers, and vice-versa.

12 Lee (2011) also uses the ratio of people over 65 years-old to those 45-64 as an alternative measure of demographic variation and arrives at similar results.13 See Lee (2011) for more details including his use of the marginal opinion theory of stock price as the impetus behind changing valuations.

While the demographic explanation is very intuitive, I argue that it does not go far enough in

several respects. First, there is no consideration of the full investment opportunity set facing investors.

For example, if yields on debt securities were relatively high, there is little reason to suspect that yield-

seeking, older investors would shift their portfolios to dividend-paying stocks en masse just because they

are older. Additionally, the risk of receiving the interest payments and principal from bonds is lower

than that of receiving dividends. It would not be surprising to find that the demographic variable is

picking up the collective impact of competing yields in the bond and equity markets. Second, there is

little consideration paid to the risk-return preferences of the entire population of investors in the

existing demographic theory. For example, younger investors that are relatively risk-averse may have a

large percentage of their portfolio concentrated in income generating investments. Lease et al. (1976)

find that approximately one-third of the portfolios of highly educated young professionals are

concentrated in income securities. In other words, older investors are not the only clientele that invest

in securities that distribute cash. Finally, changes in the old-to-young ratio assume that portfolios are not

adjusted until an age reference point is hit. It is certainly possible that investors begin to adjust their

portfolios before their actual age reaches a certain number in anticipation of cash needs. The way Lee

(2011) calculates the old-young ratio would not capture this dynamic.

B. Main Hypothesis

The yield spread conjecture put forth in this paper incorporates the investment opportunity set

facing investors as well as the full set of market participants available to purchase securities. The level of

interest rates in the economy affects every investor to a certain degree as yields on outstanding and

new securities compete with other types of securities for loanable funds. This is why the yield spread

hypothesis of the dividend premium is more comprehensive than the demographic theory. Dividends

offer an easy way for companies to cater to investors seeking yield in times of low interest rates,

especially if the firm had been on the fence about initiating a dividend.

I assume that there are classes of investors that prefer dividend paying stocks, often called

dividend clienteles, because they offer regular cash payments.14 I conjecture that these investors also

consider the yields available on other types of cash distributing securities when they make their

portfolio choices. A relatively low spread between fixed-income yields and the S&P 500 dividend yield

may result in higher valuation on dividend paying stocks (i.e., a higher dividend premium) via a shift

outward in the demand curve.15 On the other hand, when the bond rate is comparatively high, dividend-

paying stocks lose their relative appeal since investors can obtain acceptable streams of cash from

interest-bearing securities. This leads to the following hypothesis:

H1: The dividend premium is inversely related to the spread between the one-year Treasury note

yields and the S&P 500 dividend yield. The higher the one-year Treasury yield compared to the dividend

yield, the lower the dividend premium. The lower the one-year Treasury yield relative to the dividend

yield, the higher the dividend premium.

I choose the one-year Treasury note yield in the dividend spread calculation to limit the

confounding factors that could impact the spread. For example, using a corporate bond yield in the

calculation of the spread above the dividend yield may reflect changes in investor sentiment or other

factors as opposed to the cash distribution comparisons I am trying to model.

14 See Brav and Heaton (2004) and Grinstein and Michaely (2005) for conflicting findings on the existence of institutional dividend clienteles and Graham and Kumar (2006) and Becker et al. (2011) for evidence of retail dividend clienteles.15 See Shleifer (1986) for evidence that equity demand curves are negatively sloped in the real world.

IV. Method and Sample

To test the yield spread hypothesis of the dividend premium I run OLS regressions using annual

times series data from 1962 to 2004.16 I include the same or very similar control variables found in other

models of the dividend premium to test the yield spread hypothesis in a multivariate framework. The

main model is (time subscripts suppressed):

DP = α + β1YIELD_SPREAD + β2ΔDEMOGRAPHIC + β3CEFD + β4 GDP_GROWTH + β5 TAX_RATIO +

β6 PROFIT_PREM + β7 CASH_PREM + β8 TIME + ε (1)

The variables, the data sources, and the expected signs on the coefficients (when particularly

relevant) are below.

A. Dependent and Main Independent Variable

DIV_PREM = the dependent variable in all models and is defined as the difference between the

natural logs of the value-weighted market-to-book ratios of dividend payers versus nonpayers.

This variable was created by BW and can be obtained from Jeffrey Wurgler’s website.17

RF_DIV_SPRD = the main independent variable of focus and is defined as the difference

between the one-year US Treasury note yield and the dividend yield of the S&P 500 index. It is a

proxy for the trade- off investors face between the risk-free yield and the dividend yield. The

data on the Treasury note is obtained from the Federal Reserve Economic Data (FRED) website

and the S&P 500 dividend yield is cross checked from various publicly available sources. A

negative slope coefficient is anticipated: as the spread between the one-year Treasury note yield

and the S&P 500 dividend yield increases, the dividend premium tends to decrease.

16 Some annual models with fewer restrictions have more observations. The monthly regressions do not contain all controls but have much larger sample sizes.17 http://people.stern.nyu.edu/jwurgler/

B. Control Variables

ΔDEMOGRAPHIC = the change in the older-to-younger ratio defined by Lee (2011) as the

proportion of the population above 65 to those aged under 45. It is a proxy for changes in the

age structure of the population. The data comes from the US Census website. The anticipated

sign is positive. A marginal increase in the proportion of the population above 65 is associated

with an increase in the dividend premium.

CEFD = the closed-end fund discount which measures the value-weighted difference between

the price of closed-end mutual funds and their net asset value. It is a proxy for investor

sentiment. The data come from Jeffrey Wurgler’s website. As in empirical tests of BW and Lee

(2011), I expect a positive coefficient.

GDP_GROWTH = the annual real GDP growth. Lee (2011) includes this variable in his models to

control for business cycle fluctuations. The data are collected from the FRED website.

TAX_RATIO = the ratio of the Federal and State marginal tax rate on qualified dividends divided

by the marginal capital gains tax rate based on a large sample of tax returns. It is a proxy for the

actual tax considerations (as opposed to the statutory rates) facing investors when choosing

between dividend-paying versus non-paying stocks. The data are generated from the TAXSIM

program on the National Bureau of Economic Research (NBER) website.18 This control is similar

to Lee (2011) but he uses statutory rates from the Citizens for Tax Justice website.

PROFIT_PREM = is the profitability premium defined by Liu and Shan (2007) as the natural log of

the ratio of the value-weighted future return-on-assets ratios for dividend payers versus

18 http://users.nber.org/~taxsim/marginal-tax-rates/at84.html

nonpayers. It is a proxy for the signaling feature of dividends.19 The data are taken from Liu and

Shan (2007) and the expected sign of the estimated coefficient is positive.

CASH_PREM = is the cash premium defined by Liu and Shan (2007) as the natural log of the ratio

of the value-weighted cash-to-asset ratio for dividend payers versus nonpayers. They use this

variable as a proxy for agency costs.20 The data are taken from Liu and Shan (2007) and the

expected coefficient is positive.

TIME = is a time trend variable included by Lee (2011) to control for the nonstationarity in the

dividend premium series.21 It is particularly important because Lee (2011) shows that the time

trend subsumes the explanatory power of the cash premium variable in Liu and Shan (2007).

C. Variables Included in Robustness Checks

ΔALT_DEMOGRAPHIC = an alternative demographic structure variable defined by Lee (2011) as

the change in the proportion of the population above 65 to those aged between 45 and 65.

BW_SENT = an alternative measure of investor sentiment calculated by BW as the principal

component of three standardized proxies: the closed-end fund discount, the equity share of all

new issues, and the average of monthly New York Stock Exchange share turnover during the

year. This variable is orthoganilized to macroeconomic variables to try and get a non-

confounded measure of sentiment.

Table 1 contains the summary statistics for the variables used in the OLS regressions. Both Baker and

Wurgler (2004) and Lee (2011) provide motivation for why OLS regressions with a time trend variable

19 See Bhattacharya (1979) for a theoretical paper of dividend signaling and Asquith and Mullins (1983) for empirical evidence.20 See Easterbrook (1984) and Jensen (1986) for discussion on how using cash to pay dividends can enhance value by reducing agency costs between managers and shareholders.21 Baker and Wurgler (2004) discuss why the dividend premium to be stationary over the long-run.

are appropriate in modeling the dividend premium.22 Notice that we include summary statistics for

monthly data when available which will be used in secondary regressions that provide support of the

main conclusion of this paper.

V. Results

Table 2 contains the results from OLS regressions using a restricted form of the formal model

laid out in equation 1. These models investigate the relationship between the dividend premium, the

yield spread variables proposed in this paper, Lee’s (2011) demographic change variables, and a linear

time trend variable in various combinations. The results from model 1 show that the dividend premium

is inversely related to the spread between the one-year Treasury note and the S&P 500 dividend yield at

the 1% significance level in a simple OLS framework. Model 2 shows that the significance of the spread

variable holds when we add a time trend variable to control for impact of the nonstationarity in the

dividend premium variable.

Models 3 and 4 add Lee’s (2011) demographic change variables to the model. The spread

variable remains significant in both models while the proxies for demographic change are both

insignificant. I interpret the results as evidence that the risk-free yield spread variable is more

comprehensive in modeling the dividend premium compared to the demographic structural change

variable because it captures the investment opportunity set and the risk preferences of all investors.

Models 5 through 8 repeat the analysis of models 1-4 but use Moody’s Baa-rated corporate

bond yield as the spread variable. The results are qualitatively similar to the results in Models 1 through

4. In this reduced framework, it appears that the spread between bond yields and the dividend premium

have the power to explain variation in the dividend premium. The results are consistent with the yield

22 The results of unit root tests of the variables can be found in Lee (2011).

spread hypothesis: the relative valuation of dividend payers to non-payers is inversely associated with

the difference between cash-distributing bonds and cash distributing equity.

Table 3 contains the results of our main analysis. Model 1 and Model 2 show that the risk-free

yield spread is inversely related to the dividend premium at the 1% significant level when controlling for

investor sentiment and the linear time trend. Model 3 and 4 show that this results hold when use the

corporate bond yield-dividend yield spread as the variable. Models 5 through 8 use the full multivariate

framework of equation 1 with alternative measures in Lee’s (2011) proxy for demographic change and

an alternative measure of investor sentiment. The results show strong support for the yield spread

hypothesis of the dividend premium. The dividend premium is strongly and inversely associated with

changes in the yields available to investors.

Models 9 through 12 replicate the previous four models but use the corporate bond spread as

the main variable of interest in the yield spread hypothesis. The results are weaker or insignificant in this

case. I attribute this to the fact that the spread between the corporate bond yield and the dividend yield

may be picking up some of the explanatory power the sentiment and economic variables picked up. For

example, in times of poor economic sentiment, the spread on the portfolio of BAA-bonds may rise faster

than the dividend yield. While a similar argument could be made for the risk-free yield spread variable,

the direction of the change would appear to bias against finding my result. For example, when

sentiment is low, it is likely that the yield on the safe risk free asset is relatively low and the dividend

yield is relatively high as equity share prices (the denominator in the dividend yield calculation) have

come down. This would bias against my finding of an inverse relationship which is not the case based on

my empirical results.

Table 4 contains the results from monthly regressions of the dividend premium on the variables

where the data is available. Notice that sentiment spread and time seem to play a large role in the

annual data and this persists on the monthly level. The significance levels on the yield spread variables

are very high. While access to monthly data on the full set of control variables would diminish the

significance levels, it is highly unlikely to full suppress the explanatory power given the earlier results.

Thus, I take this as preliminary evidence that the results hold on a short-term basis as well.

VI. Concluding Remarks

I find that time variation in the relative valuation between stocks that pay dividends and stocks

that do not, the “dividend premium” as defined by Baker and Wurgler (2004), is related to the

investment opportunity set facing market participants. Specifically, when the spread between the one-

year Treasury note and the S&P 500 dividend yield is relative small, the dividend premium tends to be

high, and vice versa. In other words, investors appear to place higher relative valuations on dividend

paying stocks when they cannot find attractive yields in the default risk-free fixed income market.

The results are consistent with anecdotal evidence from the current low interest environment

where numerous financial reporters have discussed the relative appeal of dividend-paying stocks based

on their yields. The statistical significance of the risk-free yield spread variable in explaining variation in

the dividend premium holds after controlling for other variables that may affect the dividend premium,

such as investor sentiment, age variation in the population, agency costs, tax differentials, business cycle

fluctuations, and profitability. I also show that the spread between a portfolio of Moody’s Baa-rated

corporate bonds and the dividend yield, which is more likely to reflect investor sentiment and the risk

premium, is weakly or not associated with the dividend premium in the main multivariate framework.

These results are consistent with investors placing a premium valuation on dividend paying stocks when

their yield is comparatively high compared to default risk-free bond yields and vice versa.

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Table 1: Summary Statistics, 1961-2010*

Dividend Premium (Annual) DP

Dividend Premium (Monthly) DP

1-Year Treasury Yield minus S&P 500 Dividend Yield (Annual) RFSPRD

1-Year Treasury Yield minus S&P 500 Dividend Yield (Monthly) RFSPRD_M

Moody's Baa Bond Yield minus S&P 500 Dividend Yield (Annual) BAASPRD

Moody's Baa Bond Yield minus S&P 500 Dividend Yield (Monthly) BAASPRD_M

Increase in older-to-younger ratio ΔOLDYNG

Increase in prime consumers to prime savers ratio ΔCONSAV

Closed-end fund discount (Annual) CEFD

Closed-end fund discount (Monthly) CEFD

Mean -2.708 -5.109 0.0263 0.0299 0.0555 0.0598 0.0017 0.0006 8.346 8.962Standard Deviation 16.689 14.153 0.0238 0.0236 0.0215 0.0186 0.0013 0.0099 7.295 7.448Minimum -33.79 -50.23 -0.0280 -0.0296 0.0162 0.0183 -0.0043 -0.0191 -10.91 -10.91Maximum 31.23 31.63 0.0942 0.1172 0.1142 0.1163 0.0051 0.0152 23.53 25.28Observations 50 545 50 545 50 545 50 50 50 545

Baker-Wurgler Sentiment Index (Annual) SENT

Baker-Wurgler Sentiment Index (Monthly) SENT

Real GDP growth GDP

Capital gains tax to dividend income tax ratio TAX

Profitability Premium PROFIT

Cash Premium CASH

Time (Annual) TIME

Time (Monthly) TIME

Mean 0.253 0 0.0318 0.696 50.67 -61.69 25.5 273.5Standard Deviation 0.844 1 0.0221 0.2673 36.75 75.6 14.58 157.76Minimum -1.813 -3.527 -0.0280 0.3422 15.8 -188.97 1 1Maximum 2.451 4.367 0.0726 1.3696 239.55 88.67 50 546Observations 45 545 50 50 43 43 50 545

*The number of observations depend on the availability of the data.

Table 2: Yield Spread and Demographic ModelsModel 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model 7 Model 8

Dependent variable is the value-weighted dividend premium

Independent Variables1-Year Treasury Yield minus S&P 500 Dividend Yield -298.806*** -323.528*** -318.692*** -330.504***

(-3.84) (-6.14) (-5.16) (-5.58)Moody's Baa Bond Yield minus S&P 500 Dividend Yield -383.596*** -310.163*** -299.958*** -352.0578***

(-4.38) (-4.09) (-3.56) (-4.17)

Increase in older-to-younger ratio 103.638 1043.160(.07) (.64)

Increase in consumers-to-savers ratio 109.941 257.699(.49) (1.09)

Linear time trend -0.5228*** -.517*** -0.475** -0.333** -.341** -.202(-3.55) (-3.16) (-2.27) (-2.36) (-2.15) (-1.04)

Constant 5.162 19.146*** 18.619** 17.972** 18.589*** 23.015*** 20.714** 21.690**(1.44) (3.40) (2.62) (2.47) (2.96) (3.09) (2.33) (2.56)

R-squared 0.1816 0.3889 0.3582 0.361 0.2443 0.3201 0.2944 0.3011Observations 50 50 49 49 50 50 49 49

Table 3: Bond Yield-Dividend Yield Spread Spread with All ControlsM

odel 1M

odel 2M

odel 3M

odel 4M

odel 5M

odel 6M

odel 7M

odel 8M

odel 9M

odel 10M

odel 11M

odel 12Dependent variable is the value-weighted dividend prem

ium

Independent Variables1-Year Treasury Yield m

inus S&P 500 Dividend Yield

-320.861***-288.960***

-333.550***-304.033**

-347.518**-286.727*

(-5.47)(-4.06)

(-3.00)(-2.43)

(-2.59)(-1.90)

Moody's Baa Bond Yield m

inus S&P 500 Dividend Yield

-300.504***-251.093***

-231.750*-224.427*

-159.290-91.921

(-3.95)(-3.16)

(-1.90)(-1.86)

(-1.05)(-.59)

Increase in older-to-younger ratio2520.259

1654.8063983.211

3081.443(.93)

(.61)(1.23)

(.95)Increase in prim

e consumers to

prime savers ratio

122.219-21.509

-5.581-222.914

(.43)(-.08)

(-.02)(-.67)

Closed-end fund discount.809***

.792**1.021***

1.038***.967***

1.042***(2.72)

(2.38)(3.57)

(3.56)(3.29)

(3.28)

BW Sentim

ent-5.915**

-6.713**-7.119**

-7.598**-7.079**

-8.583***(-2.06)

(-2.29)(-2.56)

(-2.65)(-2.55)

(-3.05)

Real GDP growth-28.629

-87.901-46.162

-98.500110.860

39.60487.559

2.768(-.29)

(-.76)(-.44)

(-.79)(1.25)

(.39)(.90)

(.03)

Capital gains tax to dividend income

tax ratio15.44

7.13414.741

7.06826.787*

17.24128.693**

18.871(1.02)

(.46)(1.00)

(.46)(1.87)

(1.22)(2.12)

(1.40)

Profitability Premium

.209**.179*

.158**.140**

.255**.224**

166***0.1455**

(2.04)(1.76)

(2.48)(2.27)

(2.30)(2.08)

(2.88)(2.69)

Cash Premium

0.004.043

0.0060.047

.034.063

.052.084

(.05)(.55)

(.08)(.60)

(.43)(.81)

(.63)(1.01)

Linear time trend

-.485***-0.548***

-.302**-.399**

-.859**-.564

-.755*-0.534

-.708**-.453

-.650-.539

(-3.45)(-3.39)

(-2.34)(-2.41)

(-2.11)(-1.21)

(-1.94)(-1.14)

(-1.43)(-.90)

(-1.36)(-1.08)

Constant11.37

19.980***15.067*

22.66***14.148

10.4470.099

14.457-19.509

-2.311-14.62

2.582(1.68)

(3.73)(1.72)

(3.23)(1.32)

(.57)(.01)

(.87)(-1.19)

(-.15)(-.94)

(.18)

R-squared0.5129

0.48740.4387

0.43450.6061

0.54680.5986

0.5430.5469

0.50300.5279

0.4953Observations

5045

5045

4343

4343

4343

4343

Table 4: Monthly OLS Regressions of the Dividend Premium on Various FactorsModel 1 Model 2 Model 3 Model 4 Model 5 Model 6

Dependent variable is the value-weighted dividend premium

Independent Variables1-Year Treasury Yield minus S&P 500 Dividend Yield -245.768*** -346.844*** -327.009***

(-14.14) (-19.75) (-18.47)

Moody's Baa Bond Yield minus S&P 500 Dividend Yield -327.429*** -334.013*** -327.373***

(-14.52) (-14.43) (-13.87)

Closed-end fund discount .710*** .651***(10.12) (7.96)

BW Sentiment -1.176* -1.442**(-1.96) (-2.22)

Linear time trend -.026*** -.036 -.008* -.018***(-6.52) (-8.74) (-1.93) (-4.44)

Constant 2.238*** 5.935*** 14.407*** 14.479*** 11.104*** 19.299***(3.08) (3.13) (8.12) (8.87) (4.25) (7.69)

R-squared 0.1682 0.4293 0.3433 0.1845 0.3268 0.2322Observations 545 545 545 545 545 545