Expected Returns Across Time Scales
58 Pages Posted: 22 Oct 2010
Date Written: May 21, 2010
This paper studies the role of fluctuations in the aggregate price-earning ratio at different time scales for predicting stock returns and explore the channels through which returns are predicted. Using U.S. quarterly and international monthly data, we find that cycles in the price-earning ratio are strong and better predictors of future returns at short and intermediate horizons than the aggregate price-earning ratio and several other popular forecasting variables. Moreover, this predictability is economically profitable. The proposed method, based on a wavelet multiscaling framework, explicitly accounts for the variations at different time scales in expected cash-flow growth and expected returns.
Keywords: Financial Ratios, Return Predictability, Cycles, Wavelets
JEL Classification: G12, G17, C22
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