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The Use of Predictive Regressions at Alternative Horizons in Finance and Economics

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  • Nelson C. Mark
  • Donggyu Sul

Abstract

When a k period future return is regressed on a current variable such as the log dividend yield, the marginal significance level of the t-test that the return is unpredictable typically increases over some range of future return horizons, k. Local asymptotic power analysis shows that the power of the long-horizon predictive regression test dominates that of the short-horizon test over a nontrivial region of the admissible parameter space. In practice, small sample OLS bias, which differs under the null and the alternative, can distort the size and reduce the power gains of long-horizon tests. To overcome these problems, we suggest a moving block recursive Jackknife estimator of the predictive regression slope coefficient and test statistics that is appropriate under both the null and the alternative. The methods are applied to testing whether future stock returns are predictable. Consistent evidence in favor of return predictability shows up at the 5 year horizon.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Technical Working Papers with number 0298.

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Date of creation: Aug 2004
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Handle: RePEc:nbr:nberte:0298

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Cited by:
  1. Kim, Young Se, 2009. "Exchange rates and fundamentals under adaptive learning," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 33(4), pages 843-863, April.
  2. Erik Hjalmarsson, 2006. "New methods for inference in long-run predictive regressions," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 853, Board of Governors of the Federal Reserve System (U.S.).
  3. Hjalmarsson, Erik, 2005. "On the Predictability of Global Stock Returns," Working Papers in Economics, University of Gothenburg, Department of Economics 161, University of Gothenburg, Department of Economics.

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