Short-Term Exuberance and long-term stability: A simultaneous optimization of stock return predictions for short and long horizons

The fundamental interest of investors in econometric modelling for excess stock returns usually focuses either on short- or long-term predictions to reduce individually the investment risk. In this paper, we present a new simple model that accounts contemporaneously for short- and long-term predictions. By combining the different horizons, we can exploit the lower long-term variance to further reduce the short-term variance which is susceptible to speculative exuberance. Different combinations of short and long horizons as well as definitions of excess returns, for example, concerning the traditional short-term interest rate but also the inflation, are easily accommodated in our model. We show that the estimated relationship between excess stock returns and the predictive variables under the inflation benchmark is stable across different horizons, which is especially important for long-term real savings for pension products. We conclude the paper with a study of stock market predictions during the recent Covid-19 pandemic.