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The Scale of PredictabilityFederico M. BandiUniversity of Chicago - Booth School of Business Benoit PerronUniversity of Montreal - Department of Economics; Center for Interuniversity Research and Analysis on Organization (CIRANO); University of Montreal - Center for Interuniversity Research in Econometrics Andrea TamoniLondon School of Economics & Political Science (LSE) Claudio TebaldiBocconi University, IGIER and CAREFIN February 25, 2016 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. To justify this finding formally, we propose a novel framework in which predictability is a property of low-frequency components of both excess market returns and economic uncertainty. We show that predictability on these low-frequency components (i.e., scale-specific predictability) translates theoretically into hump-shaped patterns of slopes and coefficients of determination upon forward/backward regressions on the raw series. If past long-run uncertainty predicts future long-run returns, it also has to predict future long-run dividend growth. We report that it does so strongly.
Number of Pages in PDF File: 80 Keywords: long run, predictability, aggregation, risk-return trade-off JEL Classification: C51, E32, G12, G17 Date posted: December 5, 2012 ; Last revised: October 6, 2016Suggested CitationContact Information
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