Predicting Global Stock Returns
Board of Governors of the Federal Reserve System, International Finance Discussion Paper No. 933
56 Pages Posted: 10 Jul 2008
Date Written: June 2008
I test for stock return predictability in the largest and most comprehensive data set analyzed so far, using four common forecasting variables: the dividend- and earnings-price ratios, the short interest rate, and the term spread. The data contain over 20,000 monthly observations from 40 international markets, including 24 developed and 16 emerging economies. In addition, I develop new methods for predictive regressions with panel data. Inference based on the standard fixed effects estimator is shown to suffer from severe size distortions in the typical stock return regression, and an alternative robust estimator is proposed. The empirical results indicate that the short interest rate and the term spread are fairly robust predictors of stock returns in developed markets. In contrast, no strong or consistent evidence of predictability is found when considering the earnings- and dividend-price ratios as predictors.
Keywords: Cross-sectional dependence, Panel data, Pooled regression, Predictive regression, Stock return predictability
JEL Classification: C22, C23, G12, G15
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