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The Dog That Did Not Bark: A Defense of Return Predictability

  • John H. Cochrane

If returns are not predictable, dividend growth must be predictable, to generate the observed variation in divided yields. I find that the absence of dividend growth predictability gives stronger evidence than does the presence of return predictability. Long-horizon return forecasts give the same strong evidence. These tests exploit the negative correlation of return forecasts with dividend-yield autocorrelation across samples, together with sensible upper bounds on dividend-yield autocorrelation, to deliver more powerful statistics. I reconcile my findings with the literature that finds poor power in long-horizon return forecasts, and with the literature that notes the poor out-of-sample R-super-2 of return-forecasting regressions. The Author 2007. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please email: journals.permissions@oxfordjournals.org, Oxford University Press.

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Article provided by Society for Financial Studies in its journal The Review of Financial Studies.

Volume (Year): 21 (2008)
Issue (Month): 4 (July)
Pages: 1533-1575

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Handle: RePEc:oup:rfinst:v:21:y:2008:i:4:p:1533-1575
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  3. John H. Cochrane, 1989. "Explaining the Variance of Price Dividend Ratios," NBER Working Papers 3157, National Bureau of Economic Research, Inc.
  4. Campbell, John Y. & Yogo, Motohiro, 2006. "Efficient tests of stock return predictability," Journal of Financial Economics, Elsevier, vol. 81(1), pages 27-60, July.
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  10. Jacob Boudoukh & Roni Michaely & Matthew Richardson & Michael R. Roberts, 2007. "On the Importance of Measuring Payout Yield: Implications for Empirical Asset Pricing," Journal of Finance, American Finance Association, vol. 62(2), pages 877-915, 04.
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  13. Amit Goyal & Ivo Welch, 2004. "A Comprehensive Look at the Empirical Performance of Equity Premium Prediction," Yale School of Management Working Papers amz2412, Yale School of Management, revised 01 Jan 2006.
  14. Cochrane, John H., 1991. "Volatility tests and efficient markets : A review essay," Journal of Monetary Economics, Elsevier, vol. 27(3), pages 463-485, June.
  15. Shiller, Robert J, 1981. "Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?," American Economic Review, American Economic Association, vol. 71(3), pages 421-36, June.
  16. John Y. Campbell, 1993. "Why Long Horizons: A Study of Power Against Persistent Alternatives," NBER Technical Working Papers 0142, National Bureau of Economic Research, Inc.
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  18. Gregory Mankiw, N. & Shapiro, Matthew D., 1986. "Do we reject too often? : Small sample properties of tests of rational expectations models," Economics Letters, Elsevier, vol. 20(2), pages 139-145.
  19. 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.
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  27. Nelson, Charles R & Kim, Myung J, 1993. " Predictable Stock Returns: The Role of Small Sample Bias," Journal of Finance, American Finance Association, vol. 48(2), pages 641-61, June.
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  29. Goetzmann, W.N., 1990. "Testing The Predictive Power Of Dividend Yields," Papers fb-_90-12, Columbia - Graduate School of Business.
  30. Lewellen, Jonathan, 2004. "Predicting returns with financial ratios," Journal of Financial Economics, Elsevier, vol. 74(2), pages 209-235, November.
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