Dividend Yield Strategies in Times of Increasing Interest Rates An Examination of the Norwegian Stock Market Copenhagen Business School M.Sc. in Applied Economics and Finance Master’s Thesis Nikolai Esse Berge Erik Eugen Voll Didriksen 116561 115640 Supervisor: Michael Ahm 15.05.2019 Characters: 216,211 Pages: 108 Abstract I ___________________________________________________________________________ Abstract The current macro-economic conditions, with historically low interest rates, have created problems for investors to achieve risk-free inflation protected returns. In this environment, dividend yield strategies, such as “Dogs of the Dow” which this thesis is based on, have become increasingly attractive to yield-seeking investors. Previous research on this topic has concluded with various results. On these grounds, the aim of this thesis is to examine a high dividend yield strategy in the Norwegian stock market, on an absolute and risk-adjusted level. Further, a particular focus on periods with increasing and decreasing interest rates are more distinctly investigated. In order to control for different risk factors, such as market, size, value and momentum in our returns, a Carhart (1997) model is applied. A dividend risk factor will also be constructed to identify if there is a general dividend premium in the Norwegian market. Throughout the examination period from 2002 until 2019, our high dividend yield portfolio has significantly outperformed the benchmark index. After estimating the expected returns, adjusted for risk with the Carhart four-factor model, the high dividend yield portfolio still achieve positive abnormal returns, with a yearly average of 4.81%. Cyclical attributes are found in the portfolio, suggesting the superior returns to be dependent on a bull market. The analysis of specific interest rate periods, indicate that the strategy struggle when interest rates are rising, compared to the index – especially late in the periods. On the contrary, the dividend yield strategy is found most successful when interest rates are decreasing or stable at a low level. Contents II ___________________________________________________________________________ Contents List of Figures ........................................................................................................................ IV List of Tables ........................................................................................................................... V Abbreviation .......................................................................................................................... VI 1. Introduction ...................................................................................................................... 1 1.1 Introduction to the research topic ................................................................................ 1 1.2 Motivation and research question ............................................................................... 3 1.3 Delimitations ............................................................................................................... 3 1.4 Structure of the study .................................................................................................. 5 2. Theoretical Background................................................................................................... 6 2.1 Value investing ............................................................................................................ 6 2.1.1 Market efficiency ................................................................................................. 7 2.1.2 Behavioural finance ............................................................................................. 8 2.2 Dividends .................................................................................................................... 9 2.2.1 Dividend policy irrelevance ............................................................................... 10 2.2.2 Why some investors are dividend seeking ......................................................... 12 2.3 Explaining stock returns with risk factors ................................................................. 14 2.4 Interest rates .............................................................................................................. 17 2.4.1 The determinants of interest rates ...................................................................... 17 2.4.2 Interest rate’s impact on stock prices ................................................................. 20 2.5 Dividend yield investing strategies ........................................................................... 21 2.5.1 Dogs of the Dow ................................................................................................ 22 2.5.2 Previous research ............................................................................................... 23 2.5.3 Dividend yield investing strategies in times of low interest rates ..................... 24 3. Research Hypotheses ...................................................................................................... 26 3.1 Hypothesis 1 .............................................................................................................. 26 3.2 Hypothesis 2 .............................................................................................................. 27 4. Research Method ............................................................................................................ 29 4.1 Structure of the analysis ............................................................................................ 29 4.2 Data sample ............................................................................................................... 29 4.2.1 Benchmark index ............................................................................................... 30 4.2.2 Variables ............................................................................................................ 31 4.2.3 Returns ............................................................................................................... 32 4.2.4 Risk-free interest rate ......................................................................................... 32 4.3 Ordinary Least Squares ............................................................................................. 33 Contents III ___________________________________________________________________________ 4.4 Formation of Oslo-10 ................................................................................................ 36 4.5 Risk-adjusted returns ................................................................................................. 39 4.5.1 Sharpe ratio ........................................................................................................ 40 4.5.2 Treynor index ..................................................................................................... 41 4.5.3 Wilcoxon signed rank test .................................................................................. 42 4.6 Statistical tests for abnormal returns ......................................................................... 44 4.6.1 Weighting scheme .............................................................................................. 44 4.6.2 The Capital Asset Pricing Model ....................................................................... 46 4.6.3 The Carhart four-factor model ........................................................................... 49 4.7 Interest rate periods ................................................................................................... 53 4.8 Underlying drivers of Oslo-10 .................................................................................. 55 5. Research Results ............................................................................................................. 57 5.1 Absolute returns ........................................................................................................ 57 5.2 Risk-adjusted returns – Sharpe and Treynor ............................................................. 60 5.3 Abnormal returns – CAPM ....................................................................................... 63 5.4 Carhart four-factor model .......................................................................................... 65 5.4.1 Risk factors ........................................................................................................ 65 5.4.2 Abnormal returns – Carhart ............................................................................... 71 5.5 Interest rate implications ........................................................................................... 76 5.5.1 Decreasing and low interest rates ...................................................................... 76 5.5.2 Increasing interest rates - Period I ..................................................................... 81 5.5.3 Increasing interest rates - Period II .................................................................... 84 5.6 Explanatory factors of the results .............................................................................. 86 5.6.1 Different dividend strategies .............................................................................. 87 5.6.2 Value driving sectors ......................................................................................... 88 5.6.3 Overreaction