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Predicting Excess Stock Returns Out of Sample: Can Anything Beat the Historical Average?

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  • Campbell, John
  • Thompson, Samuel P.

Abstract

Goyal and Welch (2007) argue that the historical average excess stock return forecasts future excess stock returns better than regressions of excess returns on predictor variables. In this article, we show that many predictive regressions beat the historical average return, once weak restrictions are imposed on the signs of coefficients and return forecasts. The out-of-sample explanatory power is small, but nonetheless is economically meaningful for mean-variance investors. Even better results can be obtained by imposing the restrictions of steady-state valuation models, thereby removing the need to estimate the average from a short sample of volatile stock returns.

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File URL: http://dash.harvard.edu/bitstream/handle/1/2622619/Campbell_Predicting.pdf
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Bibliographic Info

Paper provided by Harvard University Department of Economics in its series Scholarly Articles with number 2622619.

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Date of creation: 2008
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Publication status: Published in The Review of Financial Studies
Handle: RePEc:hrv:faseco:2622619

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  1. Campbell, John Y. & Viceira, Luis M., 2002. "Strategic Asset Allocation: Portfolio Choice for Long-Term Investors," OUP Catalogue, Oxford University Press, number 9780198296942.
  2. 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.
  3. John Y. Campbell & Motohiro Yogo, 2003. "Efficient Tests of Stock Return Predictability," NBER Working Papers 10026, National Bureau of Economic Research, Inc.
  4. John Y. Campbell & Robert J. Shiller, 2001. "Valuation Ratios and the Long-Run Stock Market Outlook: An Update," NBER Working Papers 8221, National Bureau of Economic Research, Inc.
  5. Jessica A. Wachter & Missaka Warusawitharana, 2007. "Predictable Returns and Asset Allocation: Should a Skeptical Investor Time the Market?," NBER Working Papers 13165, National Bureau of Economic Research, Inc.
  6. Cavanagh, Christopher L. & Elliott, Graham & Stock, James H., 1995. "Inference in Models with Nearly Integrated Regressors," Econometric Theory, Cambridge University Press, vol. 11(05), pages 1131-1147, October.
  7. Foster, F Douglas & Smith, Tom & Whaley, Robert E, 1997. " Assessing Goodness-of-Fit of Asset Pricing Models: The Distribution of the Maximal R-Squared," Journal of Finance, American Finance Association, vol. 52(2), pages 591-607, June.
  8. Jessica A. Wachter, 2010. "Asset Allocation," Annual Review of Financial Economics, Annual Reviews, vol. 2(1), pages 175-206, December.
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