On the Economic Significance of Stock Return Predictability

80 Pages Posted: 10 May 2019 Last revised: 30 Dec 2019

See all articles by Scott Cederburg

Scott Cederburg

University of Arizona - Department of Finance

Travis L. Johnson

The University of Texas at Austin

Michael S. O'Doherty

University of Missouri at Columbia - Department of Finance

Date Written: December 29, 2019

Abstract

Kandel and Stambaugh (1996) demonstrate that forecasting variables with weak statistical support in predictive return regressions can exert considerable economic influence on portfolio decisions. Using a Bayesian vector autoregression framework with stochastic volatility in market returns and predictor variables, we assess the economic value of return predictability for investors and reach a complementary conclusion. Statistically strong predictors can be economically unimportant if they tend to take extreme values in high-volatility periods, have low persistence, or follow distributions with fat tails. Several popular predictors exhibit these properties such that their impressive statistical results do not translate into large economic gains.

Keywords: Market return predictability, Bayesian investors, Stochastic volatility, Multiperiod horizons

JEL Classification: G10, G11, G12

Suggested Citation

Cederburg, Scott and Johnson, Travis L. and O'Doherty, Michael S., On the Economic Significance of Stock Return Predictability (December 29, 2019). Available at SSRN: https://ssrn.com/abstract=3372629 or http://dx.doi.org/10.2139/ssrn.3372629

Scott Cederburg (Contact Author)

University of Arizona - Department of Finance ( email )

McClelland Hall
P.O. Box 210108
Tucson, AZ 85721-0108
United States

Travis L. Johnson

The University of Texas at Austin ( email )

2110 Speedway Stop B6600
Austin, TX Texas 78712
United States
6178995325 (Phone)

HOME PAGE: http://travislakejohnson.com

Michael S. O'Doherty

University of Missouri at Columbia - Department of Finance ( email )

Robert J. Trulaske, Sr. College of Business
401 Cornell Hall
Columbia, MO 65211
United States

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