Pockets of Predictability
86 Pages Posted: 29 Mar 2018 Last revised: 26 Mar 2019
Date Written: March 2019
For many benchmark predictor variables, short-horizon return predictability in the U.S. stock market is local in time as short periods with significant predictability (‘pockets’) are interspersed with long periods with little or no evidence of return predictability. We document this result empirically using a flexible time-varying parameter model which estimates predictive coefficients as a nonparametric function of time and explore possible explanations of this finding, including time-varying risk-premia for which we only find limited support. Conversely, pockets of return predictability are consistent with a model of incomplete learning in which investors use macroeconomic proxies to track movements in a highly persistent growth component in the underlying cash flow process and fail to incorporate effects of future revisions in beliefs into current prices.
Keywords: Return Predictability, Learning, Market Efficiency, Nonparametric Regression, Asset Pricing, Forecasting
JEL Classification: G12, C58, C14
Suggested Citation: Suggested Citation