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The Scale of Predictability

41 Pages Posted: 5 Dec 2012 Last revised: 11 Oct 2017

Federico M. Bandi

Johns Hopkins University - Carey Business School

Benoit Perron

University of Montreal - Department of Economics; Center for Interuniversity Research and Analysis on Organization (CIRANO); University of Montreal - Center for Interuniversity Research in Econometrics

Andrea Tamoni

London School of Economics & Political Science (LSE)

Claudio Tebaldi

Bocconi University - CAREFIN - Centre for Applied Research in Finance

Date Written: September 21, 2017

Abstract

We introduce a new stylized fact: the hump-shaped behavior of slopes and coefficients of determination as a function of the aggregation horizon when running (forward/backward) predictive regressions of future excess market returns onto past economic uncertainty (as proxied by market variance, consumption variance, or economic policy uncertainty). To justify this finding formally, we propose a novel modeling framework in which predictability is specified as a property of low-frequency components of both excess market returns and economic uncertainty. We dub this property scale-specific predictability. We show that classical predictive systems imply restricted forms of scale-specific predictability. We conclude that for certain predictors, like economic uncertainty, the restrictions imposed by classical predictive systems may be excessively strong.

Keywords: long run, predictability, aggregation, risk-return trade-off

JEL Classification: C51, E32, G12, G17

Suggested Citation

Bandi, Federico M. and Perron, Benoit and Tamoni, Andrea and Tebaldi, Claudio, The Scale of Predictability (September 21, 2017). Available at SSRN: https://ssrn.com/abstract=2184260 or http://dx.doi.org/10.2139/ssrn.2184260

Federico Bandi

Johns Hopkins University - Carey Business School ( email )

100 International Drive
Baltimore, MD 21202
United States

Benoit Perron

University of Montreal - Department of Economics ( email )

C.P. 6128, succursale Centre-Ville
Montreal, Quebec H3C 3J7
Canada
514-343-2126 (Phone)
514-343-5831 (Fax)

Center for Interuniversity Research and Analysis on Organization (CIRANO) ( email )

1130 Sherbrooke west, 14th floor
Montreal H3A 2M8, Quebec
Canada

University of Montreal - Center for Interuniversity Research in Econometrics ( email )

C.P. 6128, Succursale Centre-ville
Montreal, Quebec H3C 3J7
Canada

Andrea Tamoni (Contact Author)

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom
02079557303 (Phone)

Claudio Tebaldi

Bocconi University - CAREFIN - Centre for Applied Research in Finance ( email )

Via Roentgen 1
Milan, 20136
Italy

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