Hostname: page-component-cd9895bd7-gbm5v Total loading time: 0 Render date: 2024-12-26T09:42:30.107Z Has data issue: false hasContentIssue false
  • English
  • Français

Predictability in International Asset Returns: A Reexamination

Published online by Cambridge University Press:  06 April 2009

Christopher J. Neely  and
Paul Weller
Get access Rights & Permissions [Opens in a new window]

Abstract

This paper argues that inferring long-horizon asset return predictability from the properties of vector autoregressive (VAR) models on relatively short spans of data is potentially unreliable. We illustrate the problems that can arise by reexamining the findings of Bekaert and Hodrick(1992), who detected evidence of in-sample predictability in international equity and foreign exchange markets using VAR methodology for a variety of countries from 1981–1989. The VAR predictions are significantly biased in most out-of-sample forecasts and are conclusively outperformed by a simple benchmark model at horizons of up to six months. This remains true even after corrections for small sample bias and the introduction Bayesian parameter restrictions. A Monte Carlo analysis indicates that the data are unlikely to have been generated by a stable VAR. This conclusion is supported by an examination of structural break statistics. We show that implied long-horizon statistics calculated from the VAR parameter estimates are very unreliable.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 35 , Issue 4 , December 2000 , pp. 601 - 620
Copyright
Copyright © School of Business Administration, University of Washington 2000

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Footnotes

*

Research Department, Federal Reserve Bank of St. Louis. St. Louis, MO 63011, and Department of Finance, College of Business Administration, University of lowa, lowa city, IA 52240, resepectively. The views expressed are those of the authors and do not necessarily reflect official positions of the federal Reserve Bank of St. Louis or the Federal Reserve System. The authors thank Robert Hodrick for supplying the data used in Bekaert and Hodrick (1992), Morgan Stanley for providing additional financial data, and Kent Koch for excellent research assistance. We also thank Chuck Whiteman, Dick Anderson, Bob Rache, Gene Savin, Dan Thornton, and Guofu Zhou (associate editor and referee) for helpful comments. We acknowledge Robert Hodrick and Paul Sengmuller both for helpful comments and for pointing out a program error. Weller thanks the Research Department of the Federal Reserve Bank of St. Louis for its hospitality during his stay as a Visiting Scholar, when this work was initiated.

References

Andrews, D. W. K. “Tests for Parameter Instability and Structural Change with Unknown Change Point.“ Econometrica, 61 (1993), 821–856.10.2307/2951764CrossRefGoogle Scholar
Bekaert, G., and Hodrick, R. J.; and Marshall, D. A.. “on Biases in Tests of the Expectations Hypothesis of the Term Structure of Interest Rates,” Journal of Financial Economics, 44 (1997), 309–348.10.1016/S0304-405X(97)00007-XCrossRefGoogle Scholar
P., Bossaerts, and Hillion, P.. “Implementing Statistical Criteria to Select Return Forecasting Models: What Do We Leam?” Review of Financial Studies. 12 (1999), 405–428.10.1093/rfs/12.2.405Google Scholar
Campbell, J. Y. “Stock Returns and the Term Structure.” Journal of Financial Economics, 18 (1987), 373–399.10.1016/0304-405X(87)90045-610.1016/0304-405X(87)90045-6CrossRefGoogle Scholar
Campbell, J. Y.; Lo, A. W.; and MacKinlay, A. C.. The Econometrics of Financial Markets. Princeton NJ: Princeton Univ. Press (1997).CrossRefGoogle Scholar
Diebold, F. X., and Mariano, R. S.. “Comparing Predictive Accuracy.” Journal of Business and Economic Statistics, 13 (1995), 253–263.10.2307/1392185CrossRefGoogle Scholar
Doan, T. A. RATS User's Manual Version 4. Evanston, II.; Estima (1996).Google Scholar
Engle, R. F. “Estimates of the Variance of U.S. Inflation Based upon the ARCH Model.” Journal of Money, Credit, and Banking, 15 (1983), 286–301.10.2307/1992480CrossRefGoogle Scholar
Fama, E. F. “Efficient Capital Markets: A Review of Theory and Empirical Work.” Journal of Finance, 25 (1970), 383–417.10.2307/232548610.2307/2325486CrossRefGoogle Scholar
Fama, E. F., and French, K. R.. “Permancen and Temporary Components of Stock Prices,” Journal of Political Economy; 96 (1988), 246–273.10.1086/26153510.1086/261535CrossRefGoogle Scholar
Ghysels, E.; Gualy, A.; and Hall, A.. “Predictive Tests for Structural Change with Unknown Breakpoint.” Journal of Econometrics. 82 (1998), 209–233.10.1016/S0304-4076(97)00057-210.1016/S0304-4076(97)00057-2CrossRefGoogle Scholar
Hamilton, J. D. Time Series Analysis, Princeton, NJ; Princeton Univ. Press (1994).CrossRefGoogle Scholar
Hansen, L. P., and Singleton, K. J.. “Generalized Instrumental Variables Estimation of Nonlinear Rational Expectations Models.” Econometrica, 50 (1982), 1269–1286.10.2307/1911873CrossRefGoogle Scholar
Hodrick, R. J. “Dividend Yields and Expected Stock Returns; Alternative Precedures for Interence and Measurement.” Review of Financial Studies, 5 (1992), 357–386.10.1093/rfs/5.3.35710.1093/rfs/5.3.351CrossRefGoogle Scholar
Lamont, O. “Earnings and Expected Returns.” Journal of Finance, 5, (1998), 1563–1587.10.1111/0022-1082.00065CrossRefGoogle Scholar
Lamoureux, C. G., and Zhou, G.. “Temporary Components of Stock Returns; What do the Data Tell Us?” Review of Financial Studies, 9 (1996), 1033–1059.10.1093/rfs/9.4.103310.1093/rfs/9.4.1033CrossRefGoogle Scholar
Li, H., and Schadt, R.. “Multivariate Time Series Study of Excess Returns of Equity and Foreign Exchange Markets.” Journal of International Financial Markets, Institutions & Money, 5 (1995), 3–35.Google Scholar
Litterman, R. B. “Forecasting with Bayesian Vector Autoregressions—Five Years of Experience” Journal of Business and Economic Statistics, 4 (1986), 25–38.10.2307/1391384Google Scholar
Lo, A. W., and MacKinlay, A. C., “Stock Market Prices Do Not Follow Random Walks; Evidence from a Simple Specification Test.” Review of Financial Studies, 1 (1988), 41–66.10.1093/rfs/1.1.41CrossRefGoogle Scholar
Mankiw, N. G., and Shapiro, M. D.. “Do We Reject Too Often Small Sample Properties of Tests of Rational Expectations Models.” Economics Letters, 20 (1986), 139–145.10.1016/0165-1765(86)90161-8Google Scholar
Mark, N. C. “Exchange Rates and Fundamentals: Evidence on Long-Horizon Predictabiliy.” American Economic Review, 85 (1995), 201–218.Google Scholar
Meese, R. A., and Rogoff, K.. “Empirica Exchange Rate Models of the Seventies: Do They Fit Out of Sample?” Journal of International Economics, 14 (1983), 3–24.10.1016/0022-1996(83)90017-XCrossRefGoogle Scholar
Nelson, C. R., and Kim, M. J.. “Predictable Stock Returns: The Role of Small Sample Bias.” Journal of Finance, 48 (1993), 641–661.10.2307/2328916CrossRefGoogle Scholar
Newey, W. K., and West, K. D.. “Automatic Lag Selection in Covariance Matrix Estimation.” Review of Economic Studies, 61 (1994), 631–653.10.2307/229791210.2307/2297912CrossRefGoogle Scholar
Perron, P. “Testing for a Unit Root in a Time Series with a Changing Mean.” Journal of Business and Economic Statistics, 8 (1990), 153–162.10.2307/1391977CrossRefGoogle Scholar
Poterba, J. M., and Summers, L. H.. “Mean Reversion in Stock Prices.” Journal of Financial Economics, 22 (1988), 27–59.10.1016/0304-405X(88)90021-910.1016/0304-405X(88)90021-9CrossRefGoogle Scholar
Richardson, M. “Temporary Components of Stock Prices: A Skeptic's View.” Journal of Business and Economic Statistics, 11 (1993), 199–207.10.2307/1391371CrossRefGoogle Scholar
Stambaugh, R. F. “Bias in Regressions with Lagged Stochastic Regressors.” Working Paper, Center for Research in Security Prices, Univ. of chicago (1986).Google Scholar
Summers, L. H. ”Does the Stock Market Rationally Reflect Fundamental Vaules?” Journal of Finance, 41 (1986), 591–601.10.2307/232848710.1111/j.1540-6261.1986.tb04519.xCrossRefGoogle Scholar