On Measuring the Economic Significance of Asset Return Predictability

70 Pages Posted: 8 Dec 2001

See all articles by Murray Carlson

Murray Carlson

University of British Columbia (UBC) - Sauder School of Business

Hong Yan

Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF)

David A. Chapman

McIntire School, University of Virginia

Ron Kaniel

University of Rochester - Simon Business School; CEPR

Date Written: September 7, 2001

Abstract

A number of recent studies have measured the quantitative effect of excess return predictability on the optimal consumption and portfolio choices of a rational investor, and they have used the utility costs of ignoring predictability as a natural measure of economic significance. We use a general equilibrium model as a laboratory for generating predictable excess returns and for assessing the properties of the estimated consumption/portfolio rules, under both the empirical and the true dynamics of excess returns. We find that conditional rules based on ordinary least squares estimates of excess returns are severely biased, and they have a large variance across multiple simulated histories of the model. In this experiment, we find the estimation issues to be so severe that the simple unconditional consumption and portfolio rules, from Merton (1969), actually outperform (in a utility cost sense) both simple and bias-corrected empirical estimates of conditionally optimal policies.

Suggested Citation

Carlson, Murray D. and Yan, Hong and Chapman, David A. and Kaniel, Ron, On Measuring the Economic Significance of Asset Return Predictability (September 7, 2001). AFA 2002 Atlanta Meetings; Sauder School of Business Working Paper. Available at SSRN: https://ssrn.com/abstract=293422 or http://dx.doi.org/10.2139/ssrn.293422

Murray D. Carlson (Contact Author)

University of British Columbia (UBC) - Sauder School of Business ( email )

2053 Main Mall
Vancouver, BC V6T 1Z2
Canada
604-822-8358 (Phone)

Hong Yan

Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF) ( email )

Shanghai Jiao Tong University
211 West Huaihai Road
Shanghai, 200030
China

David A. Chapman

McIntire School, University of Virginia ( email )

P.O. Box 400173
Charlottesville, VA 22904-4173
United States

HOME PAGE: http://https://sites.google.com/site/davidchapmanswebsite/

Ron Kaniel

University of Rochester - Simon Business School ( email )

Rochester, NY 14627
United States

HOME PAGE: http://rkaniel.simon.rochester.edu

CEPR ( email )

London
United Kingdom

Register to save articles to
your library

Register

Paper statistics

Downloads
279
Abstract Views
1,903
rank
107,615
PlumX Metrics