Regime Specific Predictability in Predictive Regressions

32 Pages Posted: 17 Feb 2011 Last revised: 3 Mar 2011

See all articles by Jesús Gonzalo

Jesús Gonzalo

Universidad Carlos III de Madrid

Jean-Yves Pitarakis

University of Southampton - Division of Economics

Date Written: December 24, 2010

Abstract

Predictive regressions are linear specifications linking a noisy variable such as stock returns to past values of a more persistent regressor with the aim of assessing the presence of predictability. Key complications that arise are the potential presence of endogeneity and the poor adequacy of asymptotic approximations. In this paper we develop tests for uncovering the presence of predictability in such models when the strength or direction of predictability may alternate across different economically meaningful episodes. An empirical application reconsiders the Dividend Yield based return predictability and documents a strong predictability that is countercyclical, occurring solely during bad economic times.

Keywords: Endogeneity, Persistence, Return Predictability, Threshold Models

JEL Classification: C22, C50

Suggested Citation

Gonzalo, Jesus and Pitarakis, Jean-Yves, Regime Specific Predictability in Predictive Regressions (December 24, 2010). Available at SSRN: https://ssrn.com/abstract=1763263 or http://dx.doi.org/10.2139/ssrn.1763263

Jesus Gonzalo

Universidad Carlos III de Madrid ( email )

E-28903 Getafe (Madrid)
Spain

Jean-Yves Pitarakis (Contact Author)

University of Southampton - Division of Economics ( email )

Southampton, SO17 1BJ
United Kingdom
+44-23-80592631 (Phone)
+44-23-80593858 (Fax)

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