Predictive Regressions with Time-Varying Coefficients
49 Pages Posted: 15 Mar 2009
There are 3 versions of this paper
Predictive Regressions with Time-Varying Coefficients
Predictive Regressions with Time-Varying Coefficients
Date Written: March, 13 2009
Abstract
We evaluate predictive regressions that explicitly consider the time-variation of coefficients in a comprehensive Bayesian framework. This allows for fast and consistent adjustment of regression coefficients to changes in the underlying economic relationships. For monthly returns of the S&P 500 index, we demonstrate statistical as well as economic evidence of out-of-sample predictability: relative to an investor using the historic mean an investor using our methodology could have earned consistently positive utility gains (between 1.8 and 5.8% p.a. over different time periods). Furthermore, we show that predictive models with constant coefficients are dominated by models with time-varying coefficients.
Keywords: Empirical asset pricing, equity return prediction, Bayesian econometrics
JEL Classification: G12, C11
Suggested Citation: Suggested Citation
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