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Maximizing Predictability In The Stock And Bond Markets

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  • LO, ANDREW W.
  • MACKINLAY, A. CRAIG

Abstract

We construct portfolios of stocks and bonds that are maximally predictable with respect to a set of ex-ante observable economic variables, and show that these levels of predictability are statistically significant, even after controlling for data-snooping biases. We disaggregate the sources of predictability by using several asset groups — sector portfolios, market-capitalization portfolios, and stock/bond/utility portfolios — and find that the sources of maximal predictability shift considerably across asset classes and sectors as the return horizon changes. Using three out-of-sample measures of predictability — forecast errors, Merton's market-timing measure, and the profitability of asset-allocation strategies based on maximizing predictability — we show that the predictability of the maximally predictable portfolio is genuine and economically significant.

Suggested Citation

  • Lo, Andrew W. & Mackinlay, A. Craig, 1997. "Maximizing Predictability In The Stock And Bond Markets," Macroeconomic Dynamics, Cambridge University Press, vol. 1(1), pages 102-134, January.
    • Handle: RePEc:cup:macdyn:v:1:y:1997:i:01:p:102-134_00
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    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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