We present a latent variable model of dividends that predicts, out-of-sample,
44.3% of the variation in annual dividend growth rates between 1976 and 2015.
Further, when learning about dividend dynamics is incorporated into a long-run
risks model, the model predicts, out-of-sample, 24.6% of the variation in annual
stock index returns over the same time horizon, and learning contributes over half
of the predictability in returns. These ndings support the view that both investors'
aversion to long-run risks and their learning about these risks are important in
determining the asset prices and expected returns.
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