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On the Out-of-Sample Predictability of Stock Market Returns

  • Hui Guo

    (Federal Reserve Bank of St. Louis)

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In this paper, I provide new evidence of the out-of-sample predictability of stock returns. In particular, I find that the consumption-wealth ratio in conjunction with a measure of aggregate stock market volatility exhibits substantial out-of-sample forecasting power for excess stock market returns. Also, simple trading strategies based on the documented predictability generate returns of higher mean and lower volatility than the buy-and-hold strategy does, and this difference is economically important.

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Article provided by University of Chicago Press in its journal Journal of Business.

Volume (Year): 79 (2006)
Issue (Month): 2 (March)
Pages: 645-670

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Handle: RePEc:ucp:jnlbus:v:79:y:2006:i:2:p:645-670
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  1. Martin Lettau, 2001. "Consumption, Aggregate Wealth, and Expected Stock Returns," Journal of Finance, American Finance Association, vol. 56(3), pages 815-849, 06.
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  4. Andrew Ang & Geert Bekaert, 2001. "Stock Return Predictability: Is it There?," NBER Working Papers 8207, National Bureau of Economic Research, Inc.
  5. Guo, Hui, 2004. "Limited Stock Market Participation and Asset Prices in a Dynamic Economy," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 39(03), pages 495-516, September.
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  8. Clark, Todd E. & McCracken, Michael W., 2001. "Tests of equal forecast accuracy and encompassing for nested models," Journal of Econometrics, Elsevier, vol. 105(1), pages 85-110, November.
  9. Pesaran, M Hashem & Timmermann, Allan, 1995. " Predictability of Stock Returns: Robustness and Economic Significance," Journal of Finance, American Finance Association, vol. 50(4), pages 1201-28, September.
  10. Bossaerts, Peter & Hillion, Pierre, 1999. "Implementing Statistical Criteria to Select Return Forecasting Models: What Do We Learn?," Review of Financial Studies, Society for Financial Studies, vol. 12(2), pages 405-28.
  11. Amit Goyal & Ivo Welch, 2003. "Predicting the Equity Premium with Dividend Ratios," Management Science, INFORMS, vol. 49(5), pages 639-654, May.
  12. Merton, Robert C, 1973. "An Intertemporal Capital Asset Pricing Model," Econometrica, Econometric Society, vol. 41(5), pages 867-87, September.
  13. Leitch, Gordon & Tanner, J Ernest, 1991. "Economic Forecast Evaluation: Profits versus the Conventional Error Measures," American Economic Review, American Economic Association, vol. 81(3), pages 580-90, June.
  14. McCracken, Michael W., 2007. "Asymptotics for out of sample tests of Granger causality," Journal of Econometrics, Elsevier, vol. 140(2), pages 719-752, October.
  15. Balduzzi, Pierluigi & Lynch, Anthony W., 1999. "Transaction costs and predictability: some utility cost calculations," Journal of Financial Economics, Elsevier, vol. 52(1), pages 47-78, April.
  16. Bernanke, Ben & Gertler, Mark, 1989. "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review, American Economic Association, vol. 79(1), pages 14-31, March.
  17. Breen, William & Glosten, Lawrence R & Jagannathan, Ravi, 1989. " Economic Significance of Predictable Variations in Stock Index Returns," Journal of Finance, American Finance Association, vol. 44(5), pages 1177-89, December.
  18. Fama, Eugene F. & French, Kenneth R., 1989. "Business conditions and expected returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 25(1), pages 23-49, November.
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