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Predictive Systems: Living with Imperfect Predictors Author info | Abstract | Publisher info | Download info | Related research | Statistics Pástor, Luboš
Stambaugh, Robert F
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The standard regression approach to modeling return predictability seems too restrictive in one way but too lax in another. A predictive regression models expected returns as an exact linear function of a given set of predictors but does not exploit the likely economic property that innovations in expected returns are negatively correlated with unexpected returns. We develop an alternative framework---a predictive system---that accommodates imperfect predictors and beliefs about that negative correlation. In this framework, the predictive ability of imperfect predictors is supplemented by information in lagged returns as well as lags of the predictors. Compared to predictive regressions, predictive systems deliver different and substantially more precise estimates of expected returns as well as different assessments of a given predictor's usefulness.
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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number
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Date of creation: Feb 2007Date of revision:
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Keywords: expected stock return ; predictability ; predictive regression ; predictive system ; state space model ; Other versions of this item:
Find related papers by JEL classification: G1 - Financial Economics - - General Financial Markets
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