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Temporary Components of Stock Returns: What Do the Data Tell Us?

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  • Lamoureux, Christopher G
  • Zhou, Guofu

Abstract

Within the past few years several articles have suggested that returns on large equity portfolios may contain a significant predictable component at horizons three to six years. Subsequently, the tests used in these analyses have been criticized (appropriately) for having widely misunderstood size and power, rendering the conclusions inappropriate. This criticism, however, has not focused on the data, it addresses the properties of the tests. In this article we adopt a subjectivist analysis--treating the data as fixed--to ascertain whether the data have anything to say about the permanent-temporary decomposition. The data speak clearly and they tell us that for all intents and purposes, stock prices follow a random walk. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

Suggested Citation

  • Lamoureux, Christopher G & Zhou, Guofu, 1996. "Temporary Components of Stock Returns: What Do the Data Tell Us?," Review of Financial Studies, Society for Financial Studies, vol. 9(4), pages 1033-1059.
  • Handle: RePEc:oup:rfinst:v:9:y:1996:i:4:p:1033-59
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    Cited by:

    1. Ågren, Martin, 2005. "Myopic Loss Aversion, the Equity Premium Puzzle, and GARCH," Working Paper Series 2005:11, Uppsala University, Department of Economics.
    2. Ľuboš Pástor & Robert F. Stambaugh, 2012. "Are Stocks Really Less Volatile in the Long Run?," Journal of Finance, American Finance Association, vol. 67(2), pages 431-478, April.
    3. Lubos Pástor & Robert F. Stambaugh, 2009. "Predictive Systems: Living with Imperfect Predictors," Journal of Finance, American Finance Association, vol. 64(4), pages 1583-1628, August.
    4. Montero, Miquel & Perelló, Josep & Masoliver, Jaume, 2002. "Return or stock price differences," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 316(1), pages 539-560.
    5. Roskelley, Kenneth D., 2008. "Cromwell's Rule and the Role of the Prior in the Economic Metric: An Application to the Portfolio Allocation Problem," Journal of Business & Economic Statistics, American Statistical Association, vol. 26, pages 227-236, April.
    6. Eraker, Bjørn, 2008. "A Bayesian view of temporary components in asset prices," Journal of Empirical Finance, Elsevier, vol. 15(3), pages 503-517, June.
    7. Brandt, Michael W. & Kang, Qiang, 2004. "On the relationship between the conditional mean and volatility of stock returns: A latent VAR approach," Journal of Financial Economics, Elsevier, vol. 72(2), pages 217-257, May.
    8. Ang, Andrew & Chen, Joseph, 2007. "CAPM over the long run: 1926-2001," Journal of Empirical Finance, Elsevier, vol. 14(1), pages 1-40, January.
    9. Malliaropulos, Dimitrios, 1998. "International stock return differentials and real exchange rate changes," Journal of International Money and Finance, Elsevier, vol. 17(3), pages 493-511, June.
    10. Smith, L. Vanessa & Yamagata, Takashi, 2011. "Firm level return–volatility analysis using dynamic panels," Journal of Empirical Finance, Elsevier, vol. 18(5), pages 847-867.
    11. L. Vanessa Smith & Takashi Yamagata, 2008. "Firm Level Volatility-Return Analysis using Dynamic Panels," Discussion Papers 08/09, Department of Economics, University of York.
    12. Hollifield, Burton & Koop, Gary & Li, Kai, 2003. "A Bayesian analysis of a variance decomposition for stock returns," Journal of Empirical Finance, Elsevier, vol. 10(5), pages 583-601, December.
    13. Estrada, Javier, 1997. "Random walks and the temporal dimension of risk," DEE - Working Papers. Business Economics. WB 7040, Universidad Carlos III de Madrid. Departamento de Economía de la Empresa.
    14. Ogden, Joseph P., 2003. "The calendar structure of risk and expected returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 70(1), pages 29-67, October.
    15. Michael W. Brandt & Qiang Kang, 2002. "On the Relationship Between the Conditional Mean and Volatility of Stock Returns: A Latent VAR Approach," NBER Working Papers 9056, National Bureau of Economic Research, Inc.
    16. Doron Avramov & Guofu Zhou, 2010. "Bayesian Portfolio Analysis," Annual Review of Financial Economics, Annual Reviews, vol. 2(1), pages 25-47, December.
    17. Tu, Jun & Zhou, Guofu, 2004. "Data-generating process uncertainty: What difference does it make in portfolio decisions?," Journal of Financial Economics, Elsevier, vol. 72(2), pages 385-421, May.
    18. Boguth, Oliver & Carlson, Murray & Fisher, Adlai & Simutin, Mikhail, 2011. "Conditional risk and performance evaluation: Volatility timing, overconditioning, and new estimates of momentum alphas," Journal of Financial Economics, Elsevier, vol. 102(2), pages 363-389.
    19. Rapach, David & Zhou, Guofu, 2013. "Forecasting Stock Returns," Handbook of Economic Forecasting, Elsevier.
    20. Estrada, Javier, 2000. "The temporal dimension of risk," The Quarterly Review of Economics and Finance, Elsevier, vol. 40(2), pages 189-204.
    21. Gropp, Jeffrey, 2004. "Mean reversion of industry stock returns in the U.S., 1926-1998," Journal of Empirical Finance, Elsevier, vol. 11(4), pages 537-551, September.

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