Dissecting Market Expectations in the Cross-Section of Book-to-Market Ratios
Critical Finance Review
15 Pages Posted: 16 Sep 2019 Last revised: 18 Feb 2021
Date Written: February 18, 2021
This paper successfully replicates all the main results in Kelly and Pruitt (2013) for the return on the market - and provides some evidence of market premium predictability - based on their original empirical choices in the 1930-2010 sample (and, to some extent, based on other empirical choices). However, the evidence of market premium predictability, in particular, essentially disappears by making any one of the following changes: (i) Updating the sample to June 1926 - December 2019; (ii) not taking logs of the book-to-markets used as regressors; (iii) not dividing book-to-markets by their time-series standard deviations; or (iv) not taking one extra book-to-market lag (for monthly forecasts). In summary, I find no evidence that the procedure generates a valid forecasting model of market premiums with persistently positive out-of-sample R2, especially since the Oil Shock (or early 2000) in the full sample.
Keywords: Predictability, out-of-sample, equity premium, disaggregated book-to-markets.
JEL Classification: G11, G12, G14
Suggested Citation: Suggested Citation