Predicting the Market Using Information from Equity Portfolio Returns

47 Pages Posted: 19 Mar 2011

See all articles by Alex P. Taylor

Alex P. Taylor

Alliance Manchester Business School

Michael J. Brennan

University of California, Los Angeles (UCLA) - Finance Area

Date Written: November 1, 2010

Abstract

In this paper we provide new evidence on the predictability of aggregate stock market returns, and new time series of the expected excess returns on common stocks. We extract aggregate discount rate news from equity portfolio returns and use this information to construct estimates of expected excess market returns. We find that a linear combination of the lagged returns on the market portfolio, on small firms with high book-to-market ratios and on large firms with low book-to-market ratios contains information about future market returns over horizons of a few quarters. In contrast, the lagged returns on the market portfolio and 6 portfolios formed on the basis of dividend yield provide information that is useful for predicting market returns at business cycle horizons or longer. Moreover, the conditioning information we find is largely uncorrelated with commonly used predictor variables such as the market dividend yield and the CAY variable of Lettau and Ludvigson. Further analysis suggests that the level of predictability found cannot be attributed to data-mining bias.

Keywords: predictability, equity premium

JEL Classification: G10, G12

Suggested Citation

Taylor, Alex P. and Brennan, Michael John, Predicting the Market Using Information from Equity Portfolio Returns (November 1, 2010). Available at SSRN: https://ssrn.com/abstract=1786531 or http://dx.doi.org/10.2139/ssrn.1786531

Alex P. Taylor (Contact Author)

Alliance Manchester Business School ( email )

Crawford House
Oxford Road
Manchester M13 9PL
United Kingdom

Michael John Brennan

University of California, Los Angeles (UCLA) - Finance Area ( email )

Los Angeles, CA 90095-1481
United States
310-825 3587 (Phone)
310-206 8419 (Fax)

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