Expected returns and expected dividend growth in Europe: Legal origin, institutional, and financial determinants

• Main Authors: Power, D. (Author), Rambaccussing, D. (Author)
• Format: Article
• Language: English
• Published: John Wiley and Sons Ltd 2018
• Subjects: economic growth; Europe; European markets; financial market; financing; legal origins; present value; profitability; state space; stock market
• Online Access: View Fulltext in Publisher

 This paper uses a present value approach to show that price movements for equity indices in a sample of European stock markets can be traced to legal origin, institutional, and corporate financial factors. The present value literature states that stock indices move due to changes either in discount rates, dividend growth, or a combination of the two. Empirically, little is known about the mechanism through which legal, institutional, and corporate financial factors influence these variables, especially in a European context. The current paper attempts to plug this gap in the literature. Using the state space approach, we show that although expected returns are highly persistent, expected dividend growth tends to vary across the sample. Movements in markets are mainly due to changes in the discount rate. However, there appears to be a difference in the proportion of movements attributable to discount rate and dividend growth components. Stock markets in civil law countries tend to have a stronger link with the dividend growth variables as well as market size and activity measures. Expected dividend growth is also driven by profitability factors in both types of country. By contrast, there is no strong evidence of corporate indicators influencing expected returns. © 2018 John Wiley & Sons, Ltd.