Pockets of Predictability

69 Pages Posted: 29 Mar 2018 Last revised: 24 Apr 2018

Leland Farmer

University of Virginia

Lawrence Schmidt

MIT Sloan School of Management

Allan Timmermann

UCSD ; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: March 28, 2018

Abstract

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 fi nding, including time-varying risk-premia. We fi nd 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

Farmer, Leland and Schmidt, Lawrence and Timmermann, Allan, Pockets of Predictability (March 28, 2018). Available at SSRN: https://ssrn.com/abstract=3152386 or http://dx.doi.org/10.2139/ssrn.3152386

Leland Farmer (Contact Author)

University of Virginia ( email )

237 Monroe Hall
P.O. Box 400182
Charlottesville, VA 22904-418
United States

Lawrence Schmidt

MIT Sloan School of Management ( email )

77 Massachusetts Avenue
Cambridge, MA 02139-4307
United States

HOME PAGE: http://https://sites.google.com/site/lawrencedwschmidt/home

Allan Timmermann

UCSD ( email )

9500 Gilman Drive
La Jolla, CA 92093-0553
United States
858-534-0894 (Phone)

HOME PAGE: http://rady.ucsd.edu/people/faculty/timmermann/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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