This file is part of IDEAS, which uses RePEc data


[ Papers | Articles | Software | Books | Chapters | Authors | Institutions | JEL Classification | NEP reports | Search | New papers by email | Author registration | Rankings | Volunteers | FAQ | Blog | Help! ]

Predictive Systems: Living with Imperfect Predictors

Author info | Abstract | Publisher info | Download info | Related research | Statistics
Author Info
Pástor, Lubos
Stambaugh, Robert F

Additional information is available for the following registered author(s):

Abstract

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.

Download Info
To download:

If you experience problems downloading a file, check if you have the proper application to view it first. Information about this may be contained in the File-Format links below. In case of further problems read the IDEAS help file. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://www.cepr.org/pubs/dps/DP6076.asp
File Format: application/pdf
File Function:
Download Restriction: CEPR Discussion Papers are free to download for our researchers, subscribers and members. If you fall into one of these categories but have trouble downloading our papers, please contact us at subscribers@cepr.org

As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.

Publisher Info
Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 6076.

Download reference. The following formats are available: HTML, plain text, BibTeX, RIS (EndNote), ReDIF
Length:
Date of creation: Feb 2007
Date of revision:
Handle: RePEc:cpr:ceprdp:6076

Contact details of provider:
Postal: Centre for Economic Policy Research, 53--56 Great Sutton Street, London EC1V 0DG
Phone: 44 - 20 - 7183 8801
Fax: 44 - 20 - 7183 8820

Order Information:
Email:

For technical questions regarding this item, or to correct its listing, contact: ().

Related research
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

This paper has been announced in the following NEP Reports:

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Fama, Eugene F. & Schwert, G. William, 1977. "Asset returns and inflation," Journal of Financial Economics, Elsevier, vol. 5(2), pages 115-146, November. [Downloadable!] (restricted)
  2. Pastor, Lubos & Stambaugh, Robert F., 2002. "Mutual fund performance and seemingly unrelated assets," Journal of Financial Economics, Elsevier, vol. 63(3), pages 315-349, March. [Downloadable!] (restricted)
    Other versions:
  3. Doron Avramov, 2004. "Stock Return Predictability and Asset Pricing Models," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 17(3), pages 699-738. [Downloadable!] (restricted)
  4. Pastor, Lubos & Stambaugh, Robert F., 2002. "Investing in equity mutual funds," Journal of Financial Economics, Elsevier, vol. 63(3), pages 351-380, March. [Downloadable!] (restricted)
    Other versions:
  5. Brandt, Michael W. & Kang, Qiang, 2004. "On the relationship between the conditional mean and volatility of stock returns: A latent VAR approach," Journal of Financial Economics, Elsevier, vol. 72(2), pages 217-257, May. [Downloadable!] (restricted)
  6. Nicholas Barberis, 2000. "Investing for the Long Run when Returns Are Predictable," Journal of Finance, American Finance Association, vol. 55(1), pages 225-264, 02. [Downloadable!] (restricted)
  7. Owen Lamont, 1998. "Earnings and Expected Returns," Journal of Finance, American Finance Association, vol. 53(5), pages 1563-1587, October. [Downloadable!] (restricted)
  8. Campbell, John Y., 1987. "Stock returns and the term structure," Journal of Financial Economics, Elsevier, vol. 18(2), pages 373-399, June. [Downloadable!] (restricted)
    Other versions:
  9. Lubo Pástor, . "Portfolio Selection and Asset Pricing Models," CRSP working papers 356, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
    Other versions:
  10. Clark, Todd E. & West, Kenneth D., 2007. "Approximately normal tests for equal predictive accuracy in nested models," Journal of Econometrics, Elsevier, vol. 138(1), pages 291-311, May. [Downloadable!] (restricted)
    Other versions:
  11. John Y. Campbell & Samuel B. Thompson, 2005. "Predicting the Equity Premium Out of Sample: Can Anything Beat the Historical Average?," Harvard Institute of Economic Research Working Papers 2084, Harvard - Institute of Economic Research. [Downloadable!]
    Other versions:
  12. Llubos Pástor, 2001. "The Equity Premium and Structural Breaks," Journal of Finance, American Finance Association, vol. 56(4), pages 1207-1239, 08. [Downloadable!] (restricted)
    Other versions:
  13. Stambaugh, Robert F., 1997. "Analyzing investments whose histories differ in length," Journal of Financial Economics, Elsevier, vol. 45(3), pages 285-331, September. [Downloadable!] (restricted)
    Other versions:
  14. Andrew Ang & Geert Bekaert, 2001. "Stock Return Predictability: Is it There?," NBER Working Papers 8207, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  15. John H. Cochrane, 2006. "The Dog That Did Not Bark: A Defense of Return Predictability," NBER Working Papers 12026, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  16. Ang, Andrew & Piazzesi, Monika, 2003. "A no-arbitrage vector autoregression of term structure dynamics with macroeconomic and latent variables," Journal of Monetary Economics, Elsevier, vol. 50(4), pages 745-787, May. [Downloadable!] (restricted)
    Other versions:
  17. Michael Jansson & Marcelo J. Moreira, 2004. "Optimal Inference in Regression Models with Nearly Integrated Regressors," NBER Technical Working Papers 0303, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  18. Gregory Mankiw, N. & Shapiro, Matthew D., 1986. "Do we reject too often? : Small sample properties of tests of rational expectations models," Economics Letters, Elsevier, vol. 20(2), pages 139-145. [Downloadable!] (restricted)
    Other versions:
  19. repec:cup:etheor:v:10:y:1994:i:3-4:p:672-700 is not listed on IDEAS
  20. repec:fth:pennfi:72 is not listed on IDEAS
  21. Fama, Eugene F. & French, Kenneth R., 1988. "Dividend yields and expected stock returns," Journal of Financial Economics, Elsevier, vol. 22(1), pages 3-25, October. [Downloadable!] (restricted)
  22. Wayne E. Ferson & Sergei Sarkissian & Timothy Simin, 2002. "Spurious Regressions in Financial Economics?," NBER Working Papers 9143, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  23. Klaas Baks & Andrew Metrick & Jessica Wachter, . "Should Investors Avoid All Actively Managed Mutual Funds? A Study in Bayesian Performance Evaluation," Rodney L. White Center for Financial Research Working Papers 18-99, Wharton School Rodney L. White Center for Financial Research. [Downloadable!]
  24. Christopher L. Cavanagh & Graham Elliott & James Stock, 1995. "Inference in Models with Nearly Integrated Regressors," University of California at San Diego, Economics Working Paper Series 95-29, Department of Economics, UC San Diego.
  25. Clark, Todd E. & West, Kenneth D., 2006. "Using out-of-sample mean squared prediction errors to test the martingale difference hypothesis," Journal of Econometrics, Elsevier, vol. 135(1-2), pages 155-186. [Downloadable!] (restricted)
    Other versions:
  26. Pastor, Lubos & Stambaugh, Robert F., 2000. "Comparing asset pricing models: an investment perspective," Journal of Financial Economics, Elsevier, vol. 56(3), pages 335-381, June. [Downloadable!] (restricted)
    Other versions:
  27. Lewellen, Jonathan, 2004. "Predicting returns with financial ratios," Journal of Financial Economics, Elsevier, vol. 74(2), pages 209-235, November. [Downloadable!] (restricted)
  28. Robert F. Stambaugh, 1999. "Predictive Regressions," NBER Technical Working Papers 0240, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  29. K. J. Martijn Cremers, 2002. "Stock Return Predictability: A Bayesian Model Selection Perspective," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 15(4), pages 1223-1249.
  30. Lior Menzly & Tano Santos & Pietro Veronesi, 2004. "Understanding Predictability," Journal of Political Economy, University of Chicago Press, vol. 112(1), pages 1-47, February. [Downloadable!] (restricted)
  31. Keim, Donald B. & Stambaugh, Robert F., 1986. "Predicting returns in the stock and bond markets," Journal of Financial Economics, Elsevier, vol. 17(2), pages 357-390, December. [Downloadable!] (restricted)
    Other versions:
  32. Shiller, Robert J, 1981. "Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?," American Economic Review, American Economic Association, vol. 71(3), pages 421-36, June. [Downloadable!] (restricted)
    Other versions:
  33. Lubos Pástor & Robert F. Stambaugh, 1999. "Costs of Equity Capital and Model Mispricing," Journal of Finance, American Finance Association, vol. 54(1), pages 67-121, 02. [Downloadable!] (restricted)
    Other versions:
  34. Tano Santos & Pietro Veronesi, 2006. "Labor Income and Predictable Stock Returns," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 19(1), pages 1-44. [Downloadable!] (restricted)
  35. Erik Hjalmarsson, 2006. "Should we expect significant out-of-sample results when predicting stock returns?," International Finance Discussion Papers 855, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  36. Campbell, John Y, 1991. "A Variance Decomposition for Stock Returns," Economic Journal, Royal Economic Society, vol. 101(405), pages 157-79, March. [Downloadable!] (restricted)
    Other versions:
  37. Ferson, Wayne E & Harvey, Campbell R, 1991. "The Variation of Economic Risk Premiums," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 385-415, April. [Downloadable!] (restricted)
  38. Conrad, Jennifer & Kaul, Gautam, 1988. "Time-Variation in Expected Returns," Journal of Business, University of Chicago Press, vol. 61(4), pages 409-25, October. [Downloadable!] (restricted)
  39. Kandel, Shmuel & Stambaugh, Robert F, 1996. " On the Predictability of Stock Returns: An Asset-Allocation Perspective," Journal of Finance, American Finance Association, vol. 51(2), pages 385-424, June. [Downloadable!] (restricted)
    Other versions:
  40. Avramov, Doron, 2002. "Stock return predictability and model uncertainty," Journal of Financial Economics, Elsevier, vol. 64(3), pages 423-458, June. [Downloadable!] (restricted)
  41. Christopher S. Jones & Jay Shanken, 2002. "Mutual Fund Performance with Learning Across Funds," NBER Working Papers 9392, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  42. Nelson, Charles R & Kim, Myung J, 1993. " Predictable Stock Returns: The Role of Small Sample Bias," Journal of Finance, American Finance Association, vol. 48(2), pages 641-61, June. [Downloadable!] (restricted)
  43. Lamoureux, Christopher G & Zhou, Guofu, 1996. "Temporary Components of Stock Returns: What Do the Data Tell Us?," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 9(4), pages 1033-59. [Downloadable!] (restricted)
  44. repec:cup:etheor:v:11:y:1995:i:5:p:1131-47 is not listed on IDEAS
  45. Ferson, Wayne E & Harvey, Campbell R, 1993. "The Risk and Predictability of International Equity Returns," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 6(3), pages 527-66. [Downloadable!] (restricted)
  46. Campbell, John Y. & Yogo, Motohiro, 2006. "Efficient tests of stock return predictability," Journal of Financial Economics, Elsevier, vol. 81(1), pages 27-60, July. [Downloadable!] (restricted)
    Other versions:
  47. Jessica A. Wachter & Missaka Warusawitharana, 2006. "Predictable returns and asset allocation: Should a skeptical investor time the market?," 2006 Meeting Papers 22, Society for Economic Dynamics.
    Other versions:
Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Gianni Amisano & Roberto Savona, 2008. "Imperfect predictability and mutual fund dynamics. How managers use predictors in changing systematic risk," Working Paper Series 881, European Central Bank. [Downloadable!]
Statistics
Access and download statistics

Did you know? All RePEc services are meant to be be free forever, as they are all run by volunteers.

This page was last updated on 2008-10-11.

This information is provided to you by IDEAS at the Department of Economics, College of Liberal Arts and Sciences, University of Connecticut using RePEc data on a server sponsored by the Society for Economic Dynamics.