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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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References

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Citations

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Cited by:
  1. Leonid Kogan & Raman Uppal, 2001. "Risk Aversion and Optimal Portfolio Policies in Partial and General Equilibrium Economies," NBER Working Papers 8609, National Bureau of Economic Research, Inc.
  2. Avramov, Doron, 2002. "Stock return predictability and model uncertainty," Journal of Financial Economics, Elsevier, vol. 64(3), pages 423-458, June.
  3. Doron Avramov, . "Stock-Return Predictability and Model Uncertainty," Rodney L. White Center for Financial Research Working Papers 12-00, Wharton School Rodney L. White Center for Financial Research.
  4. Hiroshi Konno & Yuuhei Morita & Rei Yamamoto, 2010. "A maximal predictability portfolio using absolute deviation reformulation," Computational Management Science, Springer, vol. 7(1), pages 47-60, January.
  5. Timmermann, Allan & Granger, Clive W. J., 2004. "Efficient market hypothesis and forecasting," International Journal of Forecasting, Elsevier, vol. 20(1), pages 15-27.
  6. Lin, Wen-Ling, 1995. "Market closure and predictability of intradaily stock returns in the United States and Japan," Journal of Empirical Finance, Elsevier, vol. 2(1), pages 19-44, March.
  7. Meghana Ayyagari & Asli Demirgüç-Kunt & Vojislav Maksimovic, 2013. "What Determines Protection of Property Rights? An Analysis of Direct and Indirect Effects," Journal of Financial Econometrics, Society for Financial Econometrics, vol. 11(4), pages 610-649, September.
  8. Andrew W. Lo & Harry Mamaysky & Jiang Wang, 2000. "Foundations of Technical Analysis: Computational Algorithms, Statistical Inference, and Empirical Implementation," NBER Working Papers 7613, National Bureau of Economic Research, Inc.
  9. Johnson, Lorne D. & Sakoulis, Georgios, 2008. "Maximizing equity market sector predictability in a Bayesian time-varying parameter model," Computational Statistics & Data Analysis, Elsevier, vol. 52(6), pages 3083-3106, February.
  10. Frenk, J.B.G. & Schaible, S., 2004. "Fractional Programming," Econometric Institute Research Papers ERS-2004-074-LIS, Erasmus University Rotterdam, Erasmus School of Economics (ESE), Econometric Institute.
  11. Pereira, Pedro Luiz Valls, 2009. "Predictability of equity models," Textos para discussão 176, Escola de Economia de São Paulo, Getulio Vargas Foundation (Brazil).
  12. Korkie, Bob & Sivakumar, Ranjini & Turtle, Harry, 2002. "The dual contributions of information instruments in return models: magnitude and direction predictability," Journal of Empirical Finance, Elsevier, vol. 9(5), pages 511-523, December.
  13. Cheung, Yin-Wong & He, Jia & Ng, Lilian K., 1997. "What are the global sources of rational variation in international equity returns?," Journal of International Money and Finance, Elsevier, vol. 16(6), pages 821-836, December.
  14. Jiang Wang, 2002. "Trading Volume and Asset Prices," Annals of Economics and Finance, Society for AEF, vol. 3(2), pages 299-359, November.
  15. Andrew W. Lo & Jiang Wang, 2001. "Trading Volume: Implications of An Intertemporal Capital Asset Pricing Model," NBER Working Papers 8565, National Bureau of Economic Research, Inc.
  16. Yochanan Shachmurove & Uri BenZion & Paul Klein & Joseph Yagil, 2001. "A Moving Average Comparison of the Tel-Aviv 25 and S&P 500 Stock Indices," Penn CARESS Working Papers 4731f3394c43bebf4d3191c81, Penn Economics Department.
  17. Chih-Ling Tsai & Hansheng Wang & Ning Zhu, 2010. "Does a Bayesian approach generate robust forecasts? Evidence from applications in portfolio investment decisions," Annals of the Institute of Statistical Mathematics, Springer, vol. 62(1), pages 109-116, February.

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