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Long Memory and the Term Structure of Risk

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  • Peter C. Schotman
  • Rolf Tschernig
  • Jan Budek

Abstract

This paper explores the implications of asset return predictability for long-term portfolio choice when return-forecasting variables are fractionally integrated. For important predictor variables, like the dividend-price ratio, and nominal and real interest rates, we estimate orders of integration around 0.8. This leads to substantial increases of the estimated long-term risk of stocks, bonds, and cash compared to estimates obtained from a stationary VAR. Results are sensitive to the inclusion of the short-term nominal interest rate in the prediction equation of excess stock returns. Jointly with the dividend-price ratio it has significant predictive power, but contrary to the dividend-price ratio the nominal interest rate does not induce mitigating effects through mean reversion. Copyright The Author 2008. Published by Oxford University Press. All rights reserved. For permissions, please e-mail: journals.permissions@oxfordjournals.org., Oxford University Press.

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Bibliographic Info

Article provided by Society for Financial Econometrics in its journal Journal of Financial Econometrics.

Volume (Year): 6 (2008)
Issue (Month): 4 (Fall)
Pages: 459-495

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Handle: RePEc:oup:jfinec:v:6:y:2008:i:4:p:459-495

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Cited by:
  1. Lubos Pastor & Robert F. Stambaugh, 2009. "Are Stocks Really Less Volatile in the Long Run?," NBER Working Papers 14757, National Bureau of Economic Research, Inc.
  2. Tschernig, Rolf & Weber, Enzo & Weigand, Roland, 2013. "Long- versus medium-run identification in fractionally integrated VAR models," University of Regensburg Working Papers in Business, Economics and Management Information Systems, University of Regensburg, Department of Economics 476, University of Regensburg, Department of Economics.
  3. Daniela Osterrieder, 2013. "Interest Rates with Long Memory: A Generalized Affine Term-Structure Model," CREATES Research Papers, School of Economics and Management, University of Aarhus 2013-17, School of Economics and Management, University of Aarhus.
  4. Gil-Alana, Luis A. & Moreno, Antonio, 2012. "Uncovering the US term premium: An alternative route," Journal of Banking & Finance, Elsevier, Elsevier, vol. 36(4), pages 1181-1193.
  5. Daniela Osterrieder & Peter C. Schotman, 2012. "The Volatility of Long-term Bond Returns: Persistent Interest Shocks and Time-varying Risk Premiums," CREATES Research Papers, School of Economics and Management, University of Aarhus 2012-35, School of Economics and Management, University of Aarhus.
  6. Carlo A. Favero & Andrea Tamoni, 2010. "Demographics and the Econometrics of the Term Structure of Stock Market Risk," Working Papers, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University 367, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.

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