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Efficient tests of stock return predictability

  • Campbell, John
  • Yogo, Motohiro

Conventional tests of the predictability of stock returns could be invalid, that is reject the null too frequently, when the predictor variable is persistent and its innovations are highly correlated with returns. We develop a pretest to determine whether the conventional t-test leads to invalid inference and an efficient test of predictability that corrects this problem. Although the conventional t-test is invalid for the dividend–price and smoothed earnings–price ratios, our test finds evidence for predictability. We also find evidence for predictability with the short rate and the long-short yield spread, for which the conventional t-test leads to valid inference.

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File URL: http://dash.harvard.edu/bitstream/handle/1/3122601/campbellssrn_stockreturn.pdf
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Paper provided by Harvard University Department of Economics in its series Scholarly Articles with number 3122601.

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Date of creation: 2006
Date of revision:
Publication status: Published in Journal of Financial Economics
Handle: RePEc:hrv:faseco:3122601
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Web page: http://www.economics.harvard.edu/

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  8. Keim, Donald B. & Stambaugh, Robert F., 1986. "Predicting returns in the stock and bond markets," Journal of Financial Economics, Elsevier, vol. 17(2), pages 357-390, December.
  9. Dufour, J.M. & Campbell, B., 1993. "Exact Nonparametric Orthogonality and Random Walk Tests," Cahiers de recherche 9326, Centre interuniversitaire de recherche en économie quantitative, CIREQ.
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  19. Campbell, John Y., 2001. "Why long horizons? A study of power against persistent alternatives," Journal of Empirical Finance, Elsevier, vol. 8(5), pages 459-491, December.
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