Hostname: page-component-78c5997874-j824f Total loading time: 0 Render date: 2024-11-14T22:58:36.376Z Has data issue: false hasContentIssue false
  • English
  • Français

Predicting Global Stock Returns

Published online by Cambridge University Press:  26 November 2009

Erik Hjalmarsson
Erik Hjalmarsson*
Affiliation:
Federal Reserve Board, Mail Stop 20, Washington, DC 20551. ehjalmar@gmail.com
Get access Rights & Permissions [Opens in a new window]

Abstract

I test for stock return predictability in the largest and most comprehensive data set analyzed so far, using four common forecasting variables: the dividend-price (DP) and earnings-price (EP) ratios, the short interest rate, and the term spread. The data contain over 20,000 monthly observations from 40 international markets, including 24 developed and 16 emerging economies. In addition, I develop new methods for predictive regressions with panel data. Inference based on the standard fixed effects estimator is shown to suffer from severe size distortions in the typical stock return regression, and an alternative robust estimator is proposed. The empirical results indicate that the short interest rate and the term spread are fairly robust predictors of stock returns in developed markets. In contrast, no strong or consistent evidence of predictability is found when considering the EP and DP ratios as predictors.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 45 , Issue 1 , February 2010 , pp. 49 - 80
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2010

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.)

References

Amihud, Y., and Hurvich, C. M.. “Predictive Regressions: A Reduced-Bias Estimation Method.” Journal of Financial and Quantitative Analysis, 39 (2004), 813–841.CrossRefGoogle Scholar
Ang, A., and Bekaert, G.. “Stock Return Predictability: Is It There?” Review of Financial Studies, 20 (2007), 651–707.CrossRefGoogle Scholar
Campbell, J. Y. “Consumption-Based Asset Pricing.” In Handbook of the Economics of Finance, Vol. 1B, Constantinides, G. M., Harris, M., and Stulz, R., eds. Amsterdam: North-Holland (2003).Google Scholar
Campbell, J. Y., and Cochrane, J. H.. “By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior.” Journal of Political Economy, 107 (1999), 205–251.CrossRefGoogle Scholar
Campbell, J. Y., and Shiller, R. J.. “Stock Prices, Earnings, and Expected Dividends.” Journal of Finance, 43 (1988), 661–676.CrossRefGoogle Scholar
Campbell, J. Y., and Thompson, S. B.. “Predicting Excess Stock Returns Out of Sample: Can Anything Beat the Historical Average?” Review of Financial Studies, 21 (2008), 1509–1531.CrossRefGoogle Scholar
Campbell, J. Y., and Yogo, M.. “Efficient Tests of Stock Return Predictability.” Journal of Financial Economics, 81 (2006), 27–60.CrossRefGoogle Scholar
Cavanagh, C. L.; Elliott, G.; and Stock, J. H.. “Inference in Models with Nearly Integrated Regressors.” Econometric Theory, 11 (1995), 1131–1147.Google Scholar
Elliott, G.; Rothenberg, T. J.; and Stock, J. H.. “Efficient Tests for an Autoregressive Unit Root.” Econometrica, 64 (1996), 813–836.Google Scholar
Fama, E. F., and French, K. R.. “Dividend Yields and Expected Stock Returns.” Journal of Financial Economics, 22 (1988), 3–25.CrossRefGoogle Scholar
Fama, E. F., and French, K. R.. “Business Conditions and Expected Returns on Stocks and Bonds.” Journal of Financial Economics, 25 (1989), 23–49.Google Scholar
Ferson, W. E., and Harvey, C. R.. “The Risk and Predictability of International Equity Returns.” Review of Financial Studies, 6 (1993), 527–566.Google Scholar
Ferson, W. E., and Harvey, C. R.. “Sources of Risk and Expected Returns in Global Equity Markets.” Journal of Banking and Finance, 18 (1994), 775–803.Google Scholar
Harvey, C. R. “The World Price of Covariance Risk.” Journal of Finance, 46 (1991), 111–157.Google Scholar
Harvey, C. R. “Predictable Risk and Returns in Emerging Markets.” Review of Financial Studies, 8 (1995), 773–816.Google Scholar
Hjalmarsson, E. “Predicting Global Stock Returns.” International Finance Discussion Paper No. 933, Board of Governors of the Federal Reserve System, Washington, DC (2008).CrossRefGoogle Scholar
Jansson, M., and Moreira, M. J.. “Optimal Inference in Regression Models with Nearly Integrated Regressors.” Econometrica, 74 (2006), 681–714.CrossRefGoogle Scholar
Jorion, P., and Goetzmann, W. N.. “Global Stock Markets in the Twentieth Century.” Journal of Finance, 54 (1999), 953–980.CrossRefGoogle Scholar
Kaminsky, G. L., and Schmukler, S. L.. “Short-Run Pain, Long-Run Gain: The Effects of Financial Liberalization.” Working Paper, George Washington University (2002).Google Scholar
Lewellen, J. “Predicting Returns with Financial Ratios.” Journal of Financial Economics, 74 (2004), 209–235.Google 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.Google Scholar
Menzly, L.; Santos, T.; and Veronesi, P.. “Understanding Predictability.” Journal of Political Economy, 112 (2004), 1–47.Google Scholar
Moon, H. R., and Phillips, P. C. B.. “Estimation of Autoregressive Roots Near Unity Using Panel Data.” Econometric Theory, 16 (2000), 927–998.CrossRefGoogle Scholar
Neyman, J., and Scott, E. L.. “Consistent Estimates Based on Partially Consistent Observations.” Econometrica, 16 (1948), 1–32.Google Scholar
Nickell, S. “Biases in Dynamic Models with Fixed Effects.” Econometrica, 49 (1981), 1417–1426.Google Scholar
Paye, B. S., and Timmermann, A.. “Instability of Return Prediction Models.” Journal of Empirical Finance, 13 (2006), 274–315.Google Scholar
Pesaran, M. H. “Estimation and Inference in Large Heterogeneous Panels with a Multifactor Error Structure.” Econometrica, 74 (2006), 967–1012.Google Scholar
Pesaran, M. H. “Testing Slope Homogeneity in Large Panels.” Journal of Econometrics, 142 (2008), 50–93.Google Scholar
Pettenuzzo, D., and Timmermann, A.. “Predictability of Stock Returns and Asset Allocation under Structural Breaks.” Working Paper, University of California at San Diego (2005).Google Scholar
Phillips, P. C. B. “Towards a Unified Asymptotic Theory for Autoregression.” Biometrika, 74 (1987), 535–547.CrossRefGoogle Scholar
Phillips, P. C. B. “Regression Theory for Near-Integrated Time Series.” Econometrica, 56 (1988), 1021–1043.Google Scholar
Phillips, P. C. B., and Moon, H. R.. “Linear Regression Limit Theory for Nonstationary Panel Data.” Econometrica, 67 (1999), 1057–1111.CrossRefGoogle Scholar
Phillips, P. C. B., and Moon, H. R.. “Nonstationary Panel Data Analysis: An Overview of Some Recent Developments.” Econometric Reviews, 19 (2000), 263–286.Google Scholar
Polk, C.; Thompson, S.; and Vuolteenaho, T.. “Cross-Sectional Forecasts of the Equity Premium.” Journal of Financial Economics, 81 (2006), 101–141.Google Scholar
Stambaugh, R. F. “Predictive Regressions.” Journal of Financial Economics, 54 (1999), 375–421.Google Scholar
Stock, J. H. “Confidence Intervals for the Largest Autoregressive Root in U.S. Economic Time Series.” Journal of Monetary Economics, 28 (1991), 435–460.CrossRefGoogle Scholar
Sul, D.; Phillips, P. C. B.; and Choi, C. Y.. “Prewhitening Bias in HAC Estimation.” Oxford Bulletin of Economics and Statistics, 67 (2005), 517–546.Google Scholar
Swamy, P. A. V. B. “Efficient Inference in a Random Coefficient Regression Model.” Econometrica, 38 (1970), 311–323.CrossRefGoogle Scholar