The DOI matches its Crossref record; 68 of the 68 references it cites were found in a registry or an index.
Reconciling the Return Predictability Evidence
Abstract
Evidence of stock-return predictability by financial ratios is still controversial, as documented by inconsistent results for in-sample and out-of-sample regressions and by substantial parameter instability. This article shows that these seemingly incompatible results can be reconciled if the assumption of a fixed steady state mean of the economy is relaxed. We find strong empirical evidence in support of shifts in the steady state and propose simple methods to adjust financial ratios for such shifts. The in-sample forecasting relationship of adjusted price ratios and future returns is statistically significant and stable over time. In real time, however, changes in the steady state make the in-sample return forecastability hard to exploit out-of-sample. The uncertainty of estimating the size of steady-state shifts rather than the estimation of their dates is responsible for the difficulty of forecasting stock returns in real time. Our conclusions hold for a variety of financial ratios and are robust to changes in the econometric technique used to estimate shifts in the steady state.
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Cites
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The Econometrics of Financial Markets
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Campbell, J. Y., Lo, A. W., & MacKinlay, A. C. (1997) · doi:10.1515/9781400830213 · Cited by 5,008
A comprehensive look at the empirical performance of equity premium prediction
Welch, I., & Goyal, A. (2008) · Review of Financial Studies · doi:10.1093/rfs/hhm014 · Cited by 3,987
The Dividend-Price Ratio and Expectations of Future Dividends and Discount Factors
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Fama, E. F., & French, K. R. (2001) · Journal of Financial Economics · doi:10.1016/s0304-405x(01)00038-1 · Cited by 3,035
Predicting excess stock returns out of sample: Can anything beat the historical average?
Campbell, J. Y., & Thompson, S. B. (2008) · Review of Financial Studies · doi:10.1093/rfs/hhm055 · Cited by 2,919
Cited by
A comprehensive look at the empirical performance of equity premium prediction
Welch, I., & Goyal, A. (2008) · Review of Financial Studies · doi:10.1093/rfs/hhm014 · Cited by 3,987
The Dog That Did Not Bark: A Defense of Return Predictability
Cochrane, J. H. (2008) · Review of Financial Studies · doi:10.1093/rfs/hhm046 · Cited by 1,227
Rapach, D., & Zhou, G. (2013) · Handbook of Economic Forecasting · doi:10.1016/b978-0-444-53683-9.00006-2 · Cited by 613
Market expectations in the cross-section of present values
KELLY, B., & PRUITT, S. (2013) · The Journal of Finance · doi:10.1111/jofi.12060 · Cited by 584
Predictive regressions with time-varying coefficients
Dangl, T., & Halling, M. (2012) · Journal of Financial Economics · doi:10.1016/j.jfineco.2012.04.003 · Cited by 548
Metadata
- Authors
- Lettau, M., & Van Nieuwerburgh, S.
- Venue
- Review of Financial Studies
- Publisher
- Oxford University Press (OUP)
- Published
- 2007-12-10
- Volume
- 21
- Issue
- 4
- Pages
- 1607-1652
- ISSN
- 0893-9454 (ISSN-L)
- 1465-7368
- OpenAlex
- W2747620798
- Cited by
- 694
- References
- 68
- FWCI
- 59.64
- Type
- journal article
- Language
- en
- Open access
- closed
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