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Modeling Expected Stock Returns for Long and Short Horizons

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  • Shmuel Kandel
  • Robert F. Stambaugh

Abstract

Expected returns over long and short horizons are modeled using two approaches: an equilibrium asset pricing model and a vector autoregression (VAR). Empirical properties of returns that are consistent with the equilibrium model’s implications include (i) an annual "equity premium" of about six percent (ii) a U-shaped pattern of autocorrelations of returns with respect to investment horizon for the R-squared in projections of stock returns on predetermined financial variables. Parameters estimated in a monthly VAR for returns and these financial variables also imply autocorrelations, R-squared values, and conditional expected returns that are close to those computed with actual long-horizon returns. Simulations indicate that such a VAR is a reasonable approximation to the equilibrium model for representing the properties short- and long-horizon returns.

Suggested Citation

  • Shmuel Kandel & Robert F. Stambaugh, "undated". "Modeling Expected Stock Returns for Long and Short Horizons," Rodney L. White Center for Financial Research Working Papers 42-88, Wharton School Rodney L. White Center for Financial Research.
  • Handle: RePEc:fth:pennfi:42-88
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    Citations

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    Cited by:

    1. Campbell, John Y, 1990. "Measuring the Persistence of Expected Returns," American Economic Review, American Economic Association, vol. 80(2), pages 43-47, May.
    2. Martin Lettau, 2001. "Consumption, Aggregate Wealth, and Expected Stock Returns," Journal of Finance, American Finance Association, vol. 56(3), pages 815-849, June.
    3. Epstein, Larry G. & Zin, Stanley E., 2001. "The independence axiom and asset returns," Journal of Empirical Finance, Elsevier, vol. 8(5), pages 537-572, December.
    4. Kandel, Shmuel & Stambaugh, Robert F., 1991. "Asset returns and intertemporal preferences," Journal of Monetary Economics, Elsevier, vol. 27(1), pages 39-71, February.
    5. Larry G. Epstein & Emmanuel Farhi & Tomasz Strzalecki, 2014. "How Much Would You Pay to Resolve Long-Run Risk?," American Economic Review, American Economic Association, vol. 104(9), pages 2680-2697, September.
    6. Lo, Andrew W & Wang, Jiang, 1995. " Implementing Option Pricing Models When Asset Returns Are Predictable," Journal of Finance, American Finance Association, vol. 50(1), pages 87-129, March.
    7. Bekaert, Geert & Hodrick, Robert J, 1992. " Characterizing Predictable Components in Excess Returns on Equity and Foreign Exchange Markets," Journal of Finance, American Finance Association, vol. 47(2), pages 467-509, June.
    8. Larry G. Epstein & Angelo Melino, 1995. "A Revealed Preference Analysis of Asset Pricing Under Recursive Utility," Review of Economic Studies, Oxford University Press, vol. 62(4), pages 597-618.
    9. Carmen Ansotegui & Maria Victoria Esteban, 2002. "Cointegration for market forecast in the Spanish stock market," Applied Economics, Taylor & Francis Journals, vol. 34(7), pages 843-857.
    10. Andrea Tamoni & Arie E.Gozluklu & Carlo A.Favero, 2008. "Demographics and fluctuations in Dividend/Price," Working Papers 345, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
    11. Lettau, Martin & Ludvigson, Sydney, 2002. "Time-varying risk premia and the cost of capital: An alternative implication of the Q theory of investment," Journal of Monetary Economics, Elsevier, vol. 49(1), pages 31-66, January.
    12. Robert F. Stambaugh, "undated". "Estimating Conditional Expectations When Volatility Fluctuates," Rodney L. White Center for Financial Research Working Papers 17-93, Wharton School Rodney L. White Center for Financial Research.
    13. Chunsheng Zhou, 1996. "Stock market fluctuations and the term structure," Finance and Economics Discussion Series 96-3, Board of Governors of the Federal Reserve System (U.S.).
    14. Chunsheng Zhou, 1996. "Forecasting long- and short-horizon stock returns in a unified framework," Finance and Economics Discussion Series 96-4, Board of Governors of the Federal Reserve System (U.S.).
    15. Lo, Andrew W. & Mackinlay, A. Craig, 1997. "Maximizing Predictability In The Stock And Bond Markets," Macroeconomic Dynamics, Cambridge University Press, vol. 1(01), pages 102-134, January.
    16. Chiang, Thomas C. & Jiang, Christine X., 1995. "Foreign exchange returns over short and long horizons," International Review of Economics & Finance, Elsevier, vol. 4(3), pages 267-282.
    17. Jacob Boudouk & Matthew Richardson, 1994. "The Statistics Of Long-Horizon Regressions Revisited," Mathematical Finance, Wiley Blackwell, vol. 4(2), pages 103-119.
    18. Fischer Black, 1989. "Mean Reversion and Consumption Smoothing," NBER Working Papers 2946, National Bureau of Economic Research, Inc.
    19. Bernard Dumas, 1993. "Partial- Vs. General-Equilibrium Models of the International Capital Market," NBER Working Papers 4446, National Bureau of Economic Research, Inc.

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