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What is the Chance that the Equity Premium Varies over Time? Evidence from Regressions on the Dividend-Price Ratio

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  • Jessica A. Wachter
  • Missaka Warusawitharana

Abstract

We examine the evidence on excess stock return predictability in a Bayesian setting in which the investor faces uncertainty about both the existence and strength of predictability. When we apply our methods to the dividend-price ratio, we find that even investors who are quite skeptical about the existence of predictability sharply modify their views in favor of predictability when confronted by the historical time series of returns and predictor variables. Correctly taking into account the stochastic properties of the regressor has a dramatic impact on inference, particularly over the 2000-2005 period.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 17334.

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Date of creation: Aug 2011
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Publication status: published as What is the chance that the equity premium varies over time? Evidence from regressions on the dividend-price ratio, with Missaka Warusawitharana, forthcoming, Journal of Econometrics.
Handle: RePEc:nbr:nberwo:17334

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  1. Hui Chen & Nengjiu Ju & Jianjun Miao, . "Dynamic Asset Allocation with Ambiguous Return Predictability," Boston University - Department of Economics - Working Papers Series wp2009-015, Boston University - Department of Economics.
  2. Michael W. Brandt & Amit Goyal & Pedro Santa-Clara & Jonathan R. Stroud, 2005. "A Simulation Approach to Dynamic Portfolio Choice with an Application to Learning About Return Predictability," Review of Financial Studies, Society for Financial Studies, vol. 18(3), pages 831-873.
  3. Avramov, Doron, 2002. "Stock return predictability and model uncertainty," Journal of Financial Economics, Elsevier, vol. 64(3), pages 423-458, June.
  4. Campbell, John Y. & Yogo, Motohiro, 2006. "Efficient tests of stock return predictability," Journal of Financial Economics, Elsevier, vol. 81(1), pages 27-60, July.
  5. Zengjing Chen & Larry Epstein, 2002. "Ambiguity, Risk, and Asset Returns in Continuous Time," Econometrica, Econometric Society, vol. 70(4), pages 1403-1443, July.
  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. John Y. Campbell, 2008. "Viewpoint: Estimating the equity premium," Canadian Journal of Economics, Canadian Economics Association, vol. 41(1), pages 1-21, February.
  8. 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.
  9. John Y. Campbell, 2007. "Estimating the Equity Premium," NBER Working Papers 13423, National Bureau of Economic Research, Inc.
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Cited by:
  1. Jessica A. Wachter, 2010. "Asset Allocation," Annual Review of Financial Economics, Annual Reviews, vol. 2(1), pages 175-206, December.
  2. Missaka Warusawitharana, 2011. "The expected real return to equity," Finance and Economics Discussion Series 2011-14, Board of Governors of the Federal Reserve System (U.S.).
  3. Efstathios Avdis & Jessica A. Wachter, 2013. "Maximum likelihood estimation of the equity premium," NBER Working Papers 19684, National Bureau of Economic Research, Inc.

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