Dividend Policy and Stock Price Volatility: An Error Corrected Approach

Abstract

The purpose of this study is to investigate the relationship between dividend policy and stock price volatility (SV) in the Sri Lankan context. Based on the Hausman test results, the cross-section random effect model (CSREM) is performed in order to test the hypotheses. The Granger causality (GC) test is employed in order to test the short-term relation between dependent and explanatory variables. The CSREM test revealed that there is a significant negative impact from dividend payout, a significant positive impact from company size and no evidence of significant impact from dividend yield (DY) on SV. Furthermore, GC tests revealed that there is no short-term impact from dividend payout on SV and it showed a feedback exists between company size and stock price volatility. It is also reported that a unidirectional causality exists from DY to SV in any lag level. The management could use dividend policy as a mechanism to control stock price volatility. They could reduce the SV by increasing their dividend payout and it is possible to increase the volatility by enhancing the DY or firms size in the short run. This study is the first to accentuate that DY has a significant impact on SV in the short run and the first to discuss the same phenomenon in the Sri Lankan context, as per the best of the authors’ knowledge.