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Why Does Return Predictability Concentrate in Bad Times?

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  • JULIEN CUJEAN
  • MICHAEL HASLER

Abstract

We build an equilibrium model to explain why stock return predictability concentrates in bad times. The key feature is that investors use different forecasting models, and hence assess uncertainty differently. As economic conditions deteriorate, uncertainty rises and investors' opinions polarize. Disagreement thus spikes in bad times, causing returns to react to past news. This phenomenon creates a positive relation between disagreement and future returns. It also generates time†series momentum, which strengthens in bad times, increases with disagreement, and crashes after sharp market rebounds. We provide empirical support for these new predictions.

Suggested Citation

  • Julien Cujean & Michael Hasler, 2017. "Why Does Return Predictability Concentrate in Bad Times?," Journal of Finance, American Finance Association, vol. 72(6), pages 2717-2758, December.
    • Handle: RePEc:bla:jfinan:v:72:y:2017:i:6:p:2717-2758
    DOI: 10.1111/jofi.12544
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