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123
A Comprehensive Look at the Empirical Performance of Equity Premium Prediction,”
, 2004
"... Abstract Economists have suggested a whole range of variables that predict the equity premium: dividend price ratios, dividend yields, earningsprice ratios, dividend payout ratios, corporate or net issuing ratios, bookmarket ratios, beta premia, interest rates (in various guises), and consumption ..."
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Cited by 279 (6 self)
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Abstract Economists have suggested a whole range of variables that predict the equity premium: dividend price ratios, dividend yields, earningsprice ratios, dividend payout ratios, corporate or net issuing ratios, bookmarket ratios, beta premia, interest rates (in various guises), and consumptionbased macroeconomic ratios (cay). Our paper comprehensively reexamines the performance of these variables, both insample and outofsample, as of 2005. We find that [a] over the last 30 years, the prediction models have failed both insample and outofsample; [b] the models are unstable, in that their outofsample predictions have performed unexpectedly poorly; [c] the models would not have helped an investor with access only to information available at the time to time the market. JEL Classification: G12, G14. * Thanks to Malcolm Baker, Ray Ball, John Campbell, John Cochrane, Francis Diebold, Ravi Jagannathan, Owen Lamont, Sydney Ludvigson, Rajnish Mehra, Michael Roberts, Jay Shanken, Samuel Thompson, Jeff Wurgler, and Yihong Xia for comments; and Todd Clark for providing us with some critical McCracken values. We especially appreciate John Campbell and Sam Thompson for iterating drafts and exchanging perspectives with (or against) our earlier draftsthis has allowed us to significantly improve.
The Dog That Did Not Bark: A Defense of Return Predictability", Review of financial Studies
, 2008
"... If returns are not predictable, dividend growth must be predictable, to generate the observed variation in divided yields. I find that the absence of dividend growth predictability gives stronger evidence than does the presence of return predictability. Longhorizon return forecasts give the same st ..."
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Cited by 169 (11 self)
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If returns are not predictable, dividend growth must be predictable, to generate the observed variation in divided yields. I find that the absence of dividend growth predictability gives stronger evidence than does the presence of return predictability. Longhorizon return forecasts give the same strong evidence. These tests exploit the negative correlation of return forecasts with dividendyield autocorrelation across samples, together with sensible upper bounds on dividendyield autocorrelation, to deliver more powerful statistics. I reconcile my findings with the literature that finds poor power in longhorizon return forecasts, and with the literature that notes the poor outofsample R2 of returnforecasting regressions. (JEL G12, G14, C22) Are stock returns predictable? Table 1 presents regressions of the real and excess valueweighted stock return on its dividendprice ratio, in annual data. In contrast to the simple random walk view, stock returns do seem predictable. Similar or stronger forecasts result from many variations of the variables and data sets. Economic significance
Predicting Excess Stock Returns Out of Sample: Can Anything Beat the Historical Average?
, 2004
"... Goyal and Welch (2006) argue that the historical average excess stock return forecasts future excess stock returns better than regressions of excess returns on predictor variables. In this paper we show that many predictive regressions beat the historical average return, once weak restrictions are i ..."
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Cited by 117 (3 self)
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Goyal and Welch (2006) argue that the historical average excess stock return forecasts future excess stock returns better than regressions of excess returns on predictor variables. In this paper we show that many predictive regressions beat the historical average return, once weak restrictions are imposed on the signs of coefficients and return forecasts. The outofsample explanatory power is small, but nonetheless is economically meaningful for meanvariance investors. Even better results can be obtained by imposing the restrictions of steadystate valuation models, thereby removing the need to estimate the average from a short sample of volatile stock returns. Towards the end of the last century, academic finance economists came to take seriously the view that aggregate stock returns are predictable. During the 1980’s a number of papers studied valuation ratios, such as the dividendprice ratio, earningsprice ratio, or smoothed earningsprice ratio. Valueoriented investors in the tradition of Graham and Dodd (1934) had always asserted that high valuation ratios are an indication of an undervalued stock market and should predict high subsequent returns, but these ideas did not carry much weight in the academic literature until authors such as Rozeff (1984), Fama and French (1988), and Campbell and Shiller (1988a,b) found that valuation ratios are positively correlated with subsequent returns and that the implied predictability of returns is substantial at longer horizons. Around the same time, several papers pointed out that yields on short and longterm Treasury and corporate bonds are correlated with subsequent stock returns [Fama and Schwert
Why is longhorizon equity less risky? A durationbased explanation of the value premium, NBER working paper
, 2005
"... We propose a dynamic riskbased model that captures the value premium. Firms are modeled as longlived assets distinguished by the timing of cash flows. The stochastic discount factor is specified so that shocks to aggregate dividends are priced, but shocks to the discount rate are not. The model im ..."
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Cited by 105 (21 self)
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We propose a dynamic riskbased model that captures the value premium. Firms are modeled as longlived assets distinguished by the timing of cash flows. The stochastic discount factor is specified so that shocks to aggregate dividends are priced, but shocks to the discount rate are not. The model implies that growth firms covary more with the discount rate than do value firms, which covary more with cash flows. When calibrated to explain aggregate stock market behavior, the model accounts for the observed value premium, the high Sharpe ratios on value firms, and the poor performance of the CAPM. THIS PAPER PROPOSES A DYNAMIC RISKBASED MODEL that captures both the high expected returns on value stocks relative to growth stocks, and the failure of the capital asset pricing model to explain these expected returns. The value premium, first noted by Graham and Dodd (1934), is the finding that assets with a high ratio of price to fundamentals (growth stocks) have low expected returns relative to assets with a low ratio of price to fundamentals (value stocks). This
Instability of Return Prediction Models
 JOURNAL OF EMPIRICAL FINANCE
, 2005
"... This study examines evidence of instability in models of ex post predictable components in stock returns related to structural breaks in the coe cients of state variables such as the lagged dividend yield, short interest rate, term spread and default premium. We estimate linear models of excess retu ..."
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Cited by 57 (7 self)
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This study examines evidence of instability in models of ex post predictable components in stock returns related to structural breaks in the coe cients of state variables such as the lagged dividend yield, short interest rate, term spread and default premium. We estimate linear models of excess returns for a set of international equity indices and test for stability of the estimated regression parameters. There is evidence of instability for the vast majority of countries. We then attempt to characterize the timing and nature of the breaks. Breaks do not generally appear to be uniform in time: di erent countries experience breaks at di erent times. We do identify a contemporaneous break for the US and UK indices in 1974. There is also some evidence of a break for a cluster of European nations during the 19781982 period. These breaks may relate to the oil price shock of 1974 and the formation of the European Monetary System in 1979. For the majority of intenational indices, the predictable component in stock returns appears to have diminished following the most recent break. We assess the adequecy of the break tests and model selection procedures in a set of
Nieuwerburgh, “Reconciling the Return Predictability Evidence
 InSample Forecasts, OutofSample Forecasts, and Parameter Instability”, Review of Financial Studies, forthcoming
, 2006
"... Evidence of stockreturn predictability by financial ratios is still controversial, as documented by inconsistent results for insample and outofsample regressions and by substantial parameter instability. This article shows that these seemingly incompatible results can be reconciled if the assu ..."
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Cited by 56 (2 self)
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Evidence of stockreturn predictability by financial ratios is still controversial, as documented by inconsistent results for insample and outofsample regressions and by substantial parameter instability. This article shows that these seemingly incompatible results can be reconciled if the assumption of a fixed steady state mean of the economy is relaxed. We find strong empirical evidence in support of shifts in the steady state and propose simple methods to adjust financial ratios for such shifts. The insample forecasting relationship of adjusted price ratios and future returns is statistically significant and stable over time. In real time, however, changes in the steady state make the insample return forecastability hard to exploit outofsample. The uncertainty of estimating the size of steadystate shifts rather than the estimation of their dates is responsible for the difficulty of forecasting stock returns in real time. Our conclusions hold for a variety of financial ratios and are robust to changes in the econometric technique used to estimate shifts in the steady state. (JEL 12, 14) 1.
Outofsample equity premium prediction: Combination forecasts and links to the real economy,
 Review of Financial Studies
, 2010
"... ..."
THE MYTH OF LONGHORIZON PREDICTABILITY
, 2005
"... The prevailing view in finance is that the evidence for longhorizon stock return predictability is significantly stronger than that for short horizons. We show that for persistent regressors, a characteristic of most of the predictive variables used in the literature, the estimators are almost perf ..."
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Cited by 35 (0 self)
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The prevailing view in finance is that the evidence for longhorizon stock return predictability is significantly stronger than that for short horizons. We show that for persistent regressors, a characteristic of most of the predictive variables used in the literature, the estimators are almost perfectly correlated across horizons under the null hypothesis of no predictability. For example, for the persistence levels of dividend yields, the analytical correlation is 99% between the 1 and 2year horizon estimators and 94 % between the 1 and 5year horizons, due to the combined effects of overlapping returns and the persistence of the predictive variable. Common sampling error across equations leads to ordinary least squares coefficient estimates and R 2 s that are roughly proportional to the horizon under the null hypothesis. This is the precise pattern found in the data. The asymptotic theory is corroborated, and the analysis extended by extensive simulation evidence. We perform joint tests across horizons for a variety of explanatory variables, and provide an alternative view of the existing evidence. I.
Growth or Glamour? Fundamentals and Systematic Risk in Stock Returns: Appendix. Available online at http://kuznets.fas.harvard.edu/˜campbell/papers.html
, 2008
"... The cash flows of growth stocks are particularly sensitive to temporary movements in aggregate stock prices, driven by shocks to market discount rates, while the cash flows of value stocks are particularly sensitive to permanent movements, driven by shocks to aggregate cash flows. Thus, the high b ..."
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Cited by 29 (3 self)
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The cash flows of growth stocks are particularly sensitive to temporary movements in aggregate stock prices, driven by shocks to market discount rates, while the cash flows of value stocks are particularly sensitive to permanent movements, driven by shocks to aggregate cash flows. Thus, the high betas of growth (value) stocks with the market’s discountrate (cashflow) shocks are determined by the cashflow fundamentals of growth and value companies. Growth stocks are not merely “glamour stocks ” whose systematic risks are purely driven by investor sentiment. More generally, the systematic risks of individual stocks with similar accounting characteristics are primarily driven by the systematic risks of their fundamentals. (JEL G12, G14, N22) Why do stock prices move together? If stocks are priced by discounting their cash flows at a rate that is constant over time, although possibly varying across stocks, then movements in stock prices are driven by news about cash flows. In this case, common variation in prices must be attributable to common variation in cash flows. If discount rates vary over time, however, then groups of stocks can move together because of common shocks to discount rates rather than