Dynamic migration between stock portfolios based on dividend yield and firm size
Financial Asset Pricing: Theory, Global Policy and Dynamics.
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This chapter uses monthly U.K. stock market data sorted into a two-dimensional set of portfolios to establish the year-on-year migration dynamics of stock movements between portfolios. The system of (monthly re-balanced) portfolios comprises six dividend yield strata (including a separate zero-dividend category) each of which is further subdivided into market capitalisation quintiles. Monthly re-balancing ensures that portfolios are constantly populated by stocks having similar dividend yield and size characteristics; the movement of stocks, year-on-year, between portfolios provides information about the relationship linking returns behaviour to yield. Simply stated, the analysis of migration patterns provides additional insights into the phenomenon of the much-quoted ‘U-shaped’ characteristic which purports to relate risk-adjusted returns to dividend yield; it does so by drawing attention to the similarities between high-yielding and zero-dividend stocks, a linkage which is de-emphasised when these are conventionally viewed as being at opposite ends of a yield spectrum. This leads to the notion of ‘adjacency’, and implies a circular, rather than linear, relationship between returns and yield; a notion supported by the relatively high levels of direct migration between these two (high- and zero-yielding) groups; and by the observation, both in this chapter and in the supporting literature, that smaller firms with high average returns are concentrated in the two groups. The analysis here of direct migration also takes account of stocks distinguished by year-on-year expansion versus year-on-year contraction; it emerges as being both robust to, and consistent with this separation. A plausible explanation for such direct migration would be one associated with ‘distress’, whereby declining price levels among such stocks tends to inflate the yield metric (implying migration toward the ‘high dividend’ stratum) as firms struggle to maintain dividend levels; ultimately, firms fall directly, upon virtually inevitable dividend cessation, into the zero-dividend category. A similar analysis applies when growing firms commence paying dividends for the first time. Finally, the analysis examines the dynamics of the process in terms of a long-run equilibrium and a speed of adjustment, treating the transition matrix as a Markov process; it finds plausible values for these parameters in the context of the UK stock market
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