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Pockets of Predictability

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  • Farmer, Leland
  • Schmidt, Lawrence
  • Timmermann, Allan G

Abstract

Return predictability in the U.S. stock market is local in time as short periods with significant predictability (`pockets') are interspersed with long periods with little or no evidence of return predictability. We document this empirically using a flexible non-parametric approach and explore possible explanations of this finding, including time-varying risk premia. We find that short-lived predictability pockets are inconsistent with a broad class of affine asset pricing models. Conversely, pockets of return predictability are more in line with a model with investors' incomplete learning about a highly persistent growth component in the underlying cash flow process which undergoes occasional regime shifts.

Suggested Citation

  • Farmer, Leland & Schmidt, Lawrence & Timmermann, Allan G, 2018. "Pockets of Predictability," CEPR Discussion Papers 12885, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:12885
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    References listed on IDEAS

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    Cited by:

    1. Demetrescu, Matei & Georgiev, Iliyan & Rodrigues, Paulo MM & Taylor, AM Robert, 2019. "Testing for Episodic Predictability in Stock Returns," Essex Finance Centre Working Papers 24137, University of Essex, Essex Business School.
    2. Timmermann, Allan G, 2018. "Forecasting Methods in Finance," CEPR Discussion Papers 12692, C.E.P.R. Discussion Papers.
    3. Gonzalo, Jesús & Pitarakis, Jean-Yves, 2019. "Predictive Regressions," UC3M Working papers. Economics 28554, Universidad Carlos III de Madrid. Departamento de Economía.

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