Academic journal article Journal of Business and Behavior Sciences

Dividend Policy and Stock Price Volatility in the U.S. Equity Capital Market

Academic journal article Journal of Business and Behavior Sciences

Dividend Policy and Stock Price Volatility in the U.S. Equity Capital Market

Article excerpt

ABSTRACT: This paper addresses the effects of factors on the volatility of a stock's price over time and what specific financial factors lead a stock to be more volatile than others. Using Ordinary Least Squares (OLS) Regression, this study tests the effects of financial variables (deemed appropriate by the finance literature) on stock price volatility (as measured by the stock's standard deviation) for a sample of over 500 firms screened from the Value Line Investment Survey database. By analyzing these selected financial factors on a large sample of firms, this study identifies those financial variables that have proven historically significant in explaining stock price volatility. The study results add to the body of dividend policy knowledge by either supporting or rejecting the theories previously advanced in the literature. Results support the idea that large dividend paying stocks are in fact less risky to own as an investment. Going forward, an investor would be advised to keep these variables in mind as the United States equity markets continue to hold large amounts of volatility and risk.

INTRODUCTION

The year 2011 was marked with high volatility in all areas of the United States equity markets. Evidence of this volatility included fluctuations of upwards of 300 basis points on the Dow Industrial Average for a single trading day. With the stock market crash in late 2008 still looming in investors' minds, their leniency for an underperforming market was at a bare minimum. Those with risk tolerance to stay in stocks looked to find safe havens to shelter themselves, while the global economy resolved its many macroeconomic issues. (Hussainey, 2011) One trend that gained much attention was the flow of funds into companies that paid a healthy dividend. Increased investment in these equities with a strong dividend contributed to the stocks' safety and stability. The investors reasoned that if the market would again turn for the worse, they would at least be able to collect a dividend check. Investors are by nature risk averse, and the volatility of their investments is important to them because it is a measure of the level of risk they are exposed to. (Hussainey, 2011)

Volatility is the rate of change in the price of a security over a given time period and, consequently, the greater the volatility the greater the risk of substantial gain or loss. If a stock is labeled as volatile, it is more difficult to forecast what the company's future share price will be. Likewise, many investors prefer stocks that support more predictable earnings and therefore carry less risk.

The issue of whether or not dividend policy has a relationship with share price volatility has been a topic of intense debate for many years. The decision of whether or not to distribute earnings to shareholders or to reinvest this money back into the firm has left the opportunity for many finance scholars and professionals to examine its various effects. Many academic works have provided evidence that both support and reject the idea that dividends reduce stock price volatility. Some argue that dividends signal to investors that the company is operating effectively, while others argue that when all other variables are fixed, the payout of dividends does not effectively reduce the stocks volatility. This research analyzes how well the payout of dividends reflects the volatility of a company's stock price when compared to the relationship that other related variables have on price volatility. This study provides a deeper understanding on the true correlation between a company's dividend policy and stock price volatility. The study investigates whether a company's dividend policy is a good proxy of stock price volatility. The purpose of this study is to test whether or not dividend payout bears a negative correlation with the stock's price volatility when compared to other variables. This negative correlation would suggest that the higher payout associates with less stock price's volatility. …

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