Abstract

http://ssrn.com/abstract=953272
 
 

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Predictive Systems: Living with Imperfect Predictors


Lubos Pastor


University of Chicago - Booth School of Business; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Robert F. Stambaugh


University of Pennsylvania - The Wharton School; National Bureau of Economic Research (NBER)

July 21, 2008

CRSP Working Paper No. 617
EFA 2007 Ljubljana Meetings Paper

Abstract:     
We develop a framework for estimating expected returns - a predictive system - that allows predictors to be imperfectly correlated with the conditional expected return. When predictors are imperfect, the estimated expected return depends on past returns in a manner that hinges on the correlation between unexpected returns and innovations in expected returns. We find empirically that prior beliefs about this correlation, which is most likely negative, substantially affect estimates of expected returns as well as various inferences about predictability, including assessments of a predictor's usefulness. Compared to standard predictive regressions, predictive systems deliver different and more precise estimates of expected returns.

Number of Pages in PDF File: 51

Keywords: predictability, expected stock return, state space model, predictive system, predictive regression, imperfect predictors, Bayesian

JEL Classification: G1

working papers series





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Date posted: February 19, 2007 ; Last revised: December 13, 2011

Suggested Citation

Pastor, Lubos and Stambaugh, Robert F., Predictive Systems: Living with Imperfect Predictors (July 21, 2008). CRSP Working Paper No. 617; EFA 2007 Ljubljana Meetings Paper. Available at SSRN: http://ssrn.com/abstract=953272 or http://dx.doi.org/10.2139/ssrn.953272

Contact Information

Lubos Pastor (Contact Author)
University of Chicago - Booth School of Business ( email )
5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
773-834-4080 (Phone)
773-702-0458 (Fax)
HOME PAGE: http://www.ChicagoGSB.edu/fac/lubos.pastor/
Centre for Economic Policy Research (CEPR)
77 Bastwick Street
London, EC1V 3PZ
United Kingdom
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Robert F. Stambaugh
University of Pennsylvania - The Wharton School ( email )
The Wharton School, Finance Department
University of Pennsylvania
Philadelphia, PA 19104-6367
United States
215-898-5734 (Phone)
215-898-6200 (Fax)

National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
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