Predictability in International Asset Returns: A Reexamination

Posted: 5 Jan 2001  

Christopher J. Neely

Federal Reserve Bank of St. Louis - Research Division

Paul A. Weller

University of Iowa - Department of Finance

Multiple version iconThere are 2 versions of this paper

Abstract

This paper argues that inferring long-horizon asset-return predictability from the properties of vector autoregressive (VAR) models on relatively short spans of data is potentially unreliable. We illustrate the problems that can arise by re-examining the findings of Bekaert and Hodrick (1992), who detected evidence of in-sample predictability in international equity and foreign exchange markets using VAR methodology for a variety of countries over the period 1981-1989. The VAR predictions are significantly biased in most out-of-sample forecasts and are conclusively outperformed by a simple benchmark model at horizons of up to six months. This remains true even after corrections for small sample bias and the introduction of Bayesian parameter restrictions. A Monte Carlo analysis indicates that the data are unlikely to have been generated by a stable VAR. This conclusion is supported by an examination of structural break statistics. Implied long-horizon statistics calculated from the VAR parameter estimates are shown to be very unreliable.

Keywords: Vector autoregression, asset price, exchange rate, forecasting

JEL Classification: C32, F30

Suggested Citation

Neely, Christopher J. and Weller, Paul A., Predictability in International Asset Returns: A Reexamination. Journal of Financial and Quantitative Analysis, Vol. 35, No. 4, December 2000. Available at SSRN: https://ssrn.com/abstract=243587

Christopher J. Neely (Contact Author)

Federal Reserve Bank of St. Louis - Research Division ( email )

411 Locust St
Saint Louis, MO 63011
United States
314-444-8568 (Phone)
314-444-8731 (Fax)

HOME PAGE: http://www.stls.frb.org/research/econ/cneely/

Paul A. Weller

University of Iowa - Department of Finance ( email )

Iowa City, IA 52242-1000
United States
319-335-1017 (Phone)
319-335-3690 (Fax)

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