Uncertainty and the predictability of stock returns

While several theoretical models imply that uncertainty has predictive ability for stock returns, few studies investigate this issue using empirical data. We fill this gap by comparing the predictive ability of uncertainty variables with the predictive ability of well‐known economic level variables. We find the in‐sample and out‐of‐sample return predictability using the combining uncertainty information. The predictability is significant from both economic and statistical perspectives. Further analysis shows that macroeconomic uncertainty and level information provide complementary predictive ability over the business cycle. We obtain stronger and more robust return predictability using both types of information together than using either source of information alone.