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Testing The Predictability Of Stock Returns

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  • Markku Lanne

Abstract

Previous literature indicates that stock returns are predictable by several strongly autocorrelated forecasting variables, especially at longer horizons. It is suggested that this finding is spurious and follows from a neglected near unit root problem. Instead of the commonly used t-test, we propose a test that can be considered as a general test of whether the return can be predicted by any highly persistent variable. Using this test, no predictability is found for U.S. stock return data from the period 1928-1996. Simulation experiments show that the standard t-test clearly overrejects whereas our proposed test controls size much better. © 2002 by the President and Fellows of Harvard College and the Massachusetts Institute of Technology

Suggested Citation

  • Markku Lanne, 2002. "Testing The Predictability Of Stock Returns," The Review of Economics and Statistics, MIT Press, vol. 84(3), pages 407-415, August.
  • Handle: RePEc:tpr:restat:v:84:y:2002:i:3:p:407-415
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    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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