IMPROVING EARNINGS AND DIVIDENDS FORECASTS USING COINTEGRATION ANALYSIS

Roya K. Ardalan
Old Dominion University

ABSTRACT

This study presents an approach for improving the accuracy of dividend and earnings
forecasts. The theory of cointegration is applied to demonstrate that dividend and earnings are
cointegrated and their relationship can be used to generate accurate forecasts for dividend and
earnings. The error correction (ECM) model of this theory is used to present the nature of the
relationship between earnings and dividends. ECMs were also used for forecasting future dividends
and earnings. The ECMs forecasts were superior compared to the alternative forecasting methods.
This result is significant since better forecasts of dividends/earnings are crucial in making
investment decisions.

Keywords: Earning forecast, dividend forecast, firm valuation, investment, cointegration theory