Efficient Tests of Stock Return Predictability
John Y. Campbell
Harvard University - Department of Economics; National Bureau of Economic Research (NBER)
Princeton University - Department of Economics; National Bureau of Economic Research
September 20, 2005
Journal of Financial Economics (JFE), Vol. 81, No. 1, 2006
Conventional tests of the predictability of stock returns could be invalid, that is reject the null too frequently, when the predictor variable is persistent and its innovations are highly correlated with returns. We develop a pretest to determine whether the conventional t-test leads to invalid inference and an efficient test of predictability that corrects this problem. Although the conventional t-test is invalid for the dividend-price and smoothed earnings-price ratios, our test finds evidence for predictability. We also find evidence for predictability with the short rate and the long-short yield spread, for which the conventional t-test leads to valid inference.
Number of Pages in PDF File: 56
Keywords: Bonferroni test, Dividend yield, Predictability, Stock returns, Unit root
JEL Classification: C12, C22, G1
Date posted: October 23, 2002 ; Last revised: June 17, 2009
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