Secular Mean Reversion and Long-Run Predictability of the Stock Market
University of Agder - Faculty of Economics
April 3, 2013
Using 141 years of data, this paper begins by performing formal tests of the random walk hypothesis in the prices of S\&P Composite Index over increasing horizons up to 40 years. Even though our results cannot support the conventional wisdom which says that the stock market is safer for long-term investors, our findings speak in favor of the mean reversion hypothesis. In particular, we find statistically significant in-sample evidence that past 15-17 year returns are able to predict future 15-17 year returns. The paper continues by investigating the out-of-sample performance of long-horizon return forecast based on the mean-reverting model. These latter tests demonstrate that the forecast based on the mean-reverting model is statistically significantly better than the forecast based on the historical-mean model. Moreover, the out-of-sample forecast based on the mean-reverting model is comparable to that based on the Robert Shiller's model that uses the cyclically adjusted price-to-earnings ratio as a predictor for long-horizon returns.
Number of Pages in PDF File: 36
Keywords: predictability, stock returns, long-run, random walk, mean reversion, bootstrap simulation
JEL Classification: C12, C14, C22, G12, G14, G17working papers series
Date posted: January 31, 2013 ; Last revised: April 10, 2013
© 2014 Social Science Electronic Publishing, Inc. All Rights Reserved.
This page was processed by apollo8 in 1.157 seconds