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Predictability in International Asset Returns: A Reexamination

  • Neely, Christopher J.
  • Weller, Paul

This paper argues that inferring long-horizon asset return predictability from the properties of vector autoregressive (VAR) models on relatively short spans of data is potentially unreliable. We illustrate the problems that can arise by reexamining the findings of Bekaert and Hodrick(1992), who detected evidence of in-sample predictability in international equity and foreign exchange markets using VAR methodology for a variety of countries from 1981–1989. The VAR predictions are significantly biased in most out-of-sample forecasts and are conclusively outperformed by a simple benchmark model at horizons of up to six months. This remains true even after corrections for small sample bias and the introduction Bayesian parameter restrictions. A Monte Carlo analysis indicates that the data are unlikely to have been generated by a stable VAR. This conclusion is supported by an examination of structural break statistics. We show that implied long-horizon statistics calculated from the VAR parameter estimates are very unreliable.

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Article provided by Cambridge University Press in its journal Journal of Financial and Quantitative Analysis.

Volume (Year): 35 (2000)
Issue (Month): 04 (December)
Pages: 601-620

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Handle: RePEc:cup:jfinqa:v:35:y:2000:i:04:p:601-620_00
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  1. Diebold, Francis X & Mariano, Roberto S, 2002. "Comparing Predictive Accuracy," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(1), pages 134-44, January.
  2. Geert Bekaert & Robert J. Hodrick & David A. Marshall, 1996. "On Biases in Tests of the Expecations Hypothesis of the Term Structure Of Interest Rates," NBER Technical Working Papers 0191, National Bureau of Economic Research, Inc.
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  6. Hodrick, Robert J, 1992. "Dividend Yields and Expected Stock Returns: Alternative Procedures for Inference and Measurement," Review of Financial Studies, Society for Financial Studies, vol. 5(3), pages 357-86.
  7. Geert Bekaert & Robert J. Hodrick, 1991. "Characterizing Predictable Components in Excess Returns on Equity and Foreign Exchange Markets," NBER Working Papers 3790, National Bureau of Economic Research, Inc.
  8. Fama, Eugene F & French, Kenneth R, 1988. "Permanent and Temporary Components of Stock Prices," Journal of Political Economy, University of Chicago Press, vol. 96(2), pages 246-73, April.
  9. Meese, Richard A. & Rogoff, Kenneth, 1983. "Empirical exchange rate models of the seventies : Do they fit out of sample?," Journal of International Economics, Elsevier, vol. 14(1-2), pages 3-24, February.
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