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Maximizing Predictability In The Stock And Bond Markets

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  • LO, ANDREW W.
  • MACKINLAY, A. CRAIG

Abstract

We construct portfolios of stocks and bonds that are maximallypredictable with respect to a set of ex-ante observable economicvariables, and show that these levels of predictability arestatistically significant, even after controlling for data-snoopingbiases. We disaggregate the sources of predictability by usingseveral asset groups sector portfolios, market-capitalizationportfolios, and stock bond utility portfolios and find that thesources of maximal predictability shift considerably across assetclasses and sectors as the return horizon changes. Using threeout-of-sample measures of predictability forecast errors, Merton smarket-timing measure, and the profitability of asset-allocationstrategies based on maximizing predictability we show that thepredictability of the maximally predictable portfolio is genuine andeconomically significant.

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Bibliographic Info

Article provided by Cambridge University Press in its journal Macroeconomic Dynamics.

Volume (Year): 1 (1997)
Issue (Month): 01 (January)
Pages: 102-134

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Handle: RePEc:cup:macdyn:v:1:y:1997:i:01:p:102-134_00

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