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Simple Forecasts and Paradigm Shifts

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  • HARRISON HONG
  • JEREMY C. STEIN
  • JIALIN YU

Abstract

We study the asset pricing implications of learning in an environment in which the true model of the world is a multivariate one, but agents update only over the class of simple univariate models. Thus, if a particular simple model does a poor job of forecasting over a period of time, it is discarded in favor of an alternative simple model. The theory yields a number of distinctive predictions for stock returns, generating forecastable variation in the magnitude of the value-glamour return differential, in volatility, and in the skewness of returns. We validate several of these predictions empirically. Copyright 2007 by The American Finance Association.

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Bibliographic Info

Article provided by American Finance Association in its journal The Journal of Finance.

Volume (Year): 62 (2007)
Issue (Month): 3 (06)
Pages: 1207-1242

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Handle: RePEc:bla:jfinan:v:62:y:2007:i:3:p:1207-1242

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  1. Hal R. Varian, 1986. "Differences of opinion in financial markets," Proceedings, Federal Reserve Bank of St. Louis, pages 3-40.
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