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Efficient tests of stock return predictability

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  • Campbell, John Y.
  • Yogo, Motohiro

Abstract

Conventional tests of the predictability of stock returns could be invalid, that is reject the null too frequently, when the predictor variable is persistent and its innovations are highly correlated with returns. We develop a pretest to determine whether the conventional t-test leads to invalid inference and an efficient test of predictability that corrects this problem. Although the conventional t-test is invalid for the dividend–price and smoothed earnings–price ratios, our test finds evidence for predictability. We also find evidence for predictability with the short rate and the long-short yield spread, for which the conventional t-test leads to valid inference.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Financial Economics.

Volume (Year): 81 (2006)
Issue (Month): 1 (July)
Pages: 27-60

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Handle: RePEc:eee:jfinec:v:81:y:2006:i:1:p:27-60

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Web page: http://www.elsevier.com/locate/inca/505576

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References

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  1. Graham Elliott & James H. Stock, 1992. "Inference in Time Series Regression When the Order of Integration of a Regressor is Unknown," NBER Technical Working Papers 0122, National Bureau of Economic Research, Inc.
  2. Campbell, John & Yogo, Motohiro, 2006. "Efficient tests of stock return predictability," Scholarly Articles 3122601, Harvard University Department of Economics.
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  9. Campbell, John & Shiller, Robert, 1988. "Stock Prices, Earnings, and Expected Dividends," Scholarly Articles 3224293, Harvard University Department of Economics.
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