Pockets of Predictability
69 Pages Posted: 29 Mar 2018 Last revised: 24 Apr 2018
Date Written: March 28, 2018
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 empirically using a flexible non-parametric approach and explore possible explanations of this finding, including time-varying risk-premia. We find that short-lived predictability pockets are inconsistent with a broad class of affine asset pricing models. Conversely, pockets of return predictability are more in line with a model with investors' incomplete learning about a highly persistent growth component in the underlying cash flow process which undergoes occasional regime shifts.
Keywords: Return Predictability, Learning, Market Efficiency, Nonparametric Regression, Asset Pricing, Forecasting
JEL Classification: G12, C58, C14
Suggested Citation: Suggested Citation