Predictability in Financial Markets: What do Survey Expectations Tell Us?

Abstract

This working paper was written by Philippe Bacchetta (University of Lausanne, FAME & CEPR), Elmar Mertens (University of Lausanne) and Eric van Wincoop (University of Virginia and NBER).

There is widespread evidence of excess return predictability in financial markets. In this paper we examine whether this predictability is related to expectational errors. To consider this issue, we use data on survey expectations of market participants in the stock market, the foreign exchange market, and the bond and money markets in various countries. We find that the predictability of expectational errors coincides with the predictability of excess returns: when a variable predicts expectational errors in a given market, it typically predicts the excess return as well. Understanding expectational errors appears crucial for explaining excess return predictability.

Keywords: excess returns, expectations survey, predictability

JEL Classification: F31, G12, G14