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Simple Forecasts and Paradigm Shifts

Author

Listed:
  • HARRISON HONG
  • JEREMY C. STEIN
  • JIALIN YU

Abstract

We study the asset pricing implications of learning in an environment in which the true model of the world is a multivariate one, but agents update only over the class of simple univariate models. Thus, if a particular simple model does a poor job of forecasting over a period of time, it is discarded in favor of an alternative simple model. The theory yields a number of distinctive predictions for stock returns, generating forecastable variation in the magnitude of the value‐glamour return differential, in volatility, and in the skewness of returns. We validate several of these predictions empirically.

Suggested Citation

  • Harrison Hong & Jeremy C. Stein & Jialin Yu, 2007. "Simple Forecasts and Paradigm Shifts," Journal of Finance, American Finance Association, vol. 62(3), pages 1207-1242, June.
    • Handle: RePEc:bla:jfinan:v:62:y:2007:i:3:p:1207-1242
    DOI: 10.1111/j.1540-6261.2007.01234.x
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    JEL classification:

    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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