Why Does Return Predictability Concentrate in Bad Times?

118 Pages Posted: 29 Jun 2017

See all articles by Julien Cujean

Julien Cujean

University of Bern - Institute for Financial Management

Michael Hasler

University of Neuchatel

Date Written: June 28, 2017

Abstract

We build an equilibrium model to explain why stock return predictability concentrates in bad times. The key feature is that investors use different forecasting models, and hence assess uncertainty differently. As economic conditions deteriorate, uncertainty rises and investors’ opinions polarize. Disagreement thus spikes in bad times, causing returns to react to past news. This phenomenon creates a positive relation between disagreement and future returns. It also generates time-series momentum, which strengthens in bad times, increases with disagreement, and crashes after sharp market rebounds. We provide empirical support for these new predictions.

Keywords: Equilibrium Asset Pricing, Learning, Disagreement, Business Cycle, Predictability, Times Series Momentum, Momentum Crashes

JEL Classification: D51, D83, G12, G14

Suggested Citation

Cujean, Julien and Hasler, Michael, Why Does Return Predictability Concentrate in Bad Times? (June 28, 2017). Journal of Finance, Forthcoming, Rotman School of Management Working Paper No. 2994327, Available at SSRN: https://ssrn.com/abstract=2994327

Julien Cujean (Contact Author)

University of Bern - Institute for Financial Management ( email )

Michael Hasler

University of Neuchatel

2, A.-L. Breguet
Neuchatel, CH-2000
Switzerland

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