The purpose of this paper is to examine the relationship between dividend policy and stock price volatility. Two key variables; dividend yield and dividend payout have been taken as the independent variables after controlling for firm size and growth in assets. The stock price volatility has been taken as the dependent variable. Data collection was carried out with a sample of 40 companies listed in the Colombo Stock Exchange, for a period of ten years from 2003 to 2012. The results of cross section random effect model 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 on stock price volatility. Furthermore, Granger causality tests revealed that there is no short term impact from dividend payout on stock price volatility and it showed a feedback exist between company size and stock price volatility in any lag level. It is evident that the dividend yield does granger cause stock price volatility and reported a unidirectional causality exists from dividend yield to stock price volatility in any lag level. Therefore, the findings suggest that, high dividend payout would lead to less volatile stock price, whilst higher dividend yield pave the way towards more volatility in stock price in the short run. This paper is the first to show that dividend yield has a significant impact on stock price volatility in the short run and the first to discuss the same phenomenon in the Sri Lankan context, to the best of the author’s knowledge.
Keywords: Cross Section Random Effect Model, Dividend Policy, Granger Causality Test and Stock Price Volatility
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