Is the Distribution of Stock Returns Predictable?
50 Pages Posted: 25 Mar 2008
Date Written: February 12, 2008
A large literature has considered predictability of the mean or volatility of stock returns but little is known about whether the distribution of stock returns more generally is predictable. We explore this issue in a quantile regression framework and consider whether a range of economic state variables are helpful in predicting different quantiles of stock returns representing left tails, right tails or shoulders of the return distribution. Many variables are found to have an asymmetric effect on the return distribution, affecting lower, central and upper quantiles very differently. Out-of-sample forecasts suggest that upper quantiles of the return distribution can be predicted by means of economic state variables although the center of the return distribution is more difficult to predict. Economic gains from utilizing information in time-varying quantile forecasts are demonstrated through portfolio selection and option trading experiments.
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