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Efficient tests of stock return predictability

  • Campbell, John Y.
  • Yogo, Motohiro

Conventional tests of the predictability of stock returns could be invalid, that is reject the null too frequently, when the predictor variable is persistent and its innovations are highly correlated with returns. We develop a pretest to determine whether the conventional t-test leads to invalid inference and an efficient test of predictability that corrects this problem. Although the conventional t-test is invalid for the dividend-price and smoothed earnings-price ratios, our test finds evidence for predictability. We also find evidence for predictability with the short rate and the long-short yield spread, for which the conventional t-test leads to valid inference.

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Article provided by Elsevier in its journal Journal of Financial Economics.

Volume (Year): 81 (2006)
Issue (Month): 1 (July)
Pages: 27-60

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Handle: RePEc:eee:jfinec:v:81:y:2006:i:1:p:27-60
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505576

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  1. Campbell, John Y. & Yogo, Motohiro, 2006. "Efficient tests of stock return predictability," Journal of Financial Economics, Elsevier, vol. 81(1), pages 27-60, July.
  2. Stambaugh, Robert F., 1999. "Predictive regressions," Journal of Financial Economics, Elsevier, vol. 54(3), pages 375-421, December.
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  8. Campbell, Bryan & Dufour, Jean-Marie, 1991. "Over-rejections in rational expectations models : A non-parametric approach to the Mankiw-Shapiro problem," Economics Letters, Elsevier, vol. 35(3), pages 285-290, March.
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