English, Article, Journal or magazine article edition: Predictable Stock Returns: Reality or Statistical Illusion? Charles R. Nelson; Myung J. Kim

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Bookmark: http://trove.nla.gov.au/version/140359
Physical Description
  • preprint
Language
  • English

Edition details

Title
  • Predictable Stock Returns: Reality or Statistical Illusion?
Author
  • Charles R. Nelson
  • Myung J. Kim
Physical Description
  • preprint
Notes
  • Recent research suggests that stock returns are predictable from fundamentals such as dividend yield, and that the degree of predictability rises with the length of the horizon over which return is measured. This paper investigates the magnitude of two sources of small ssmple bias in these reaults. First, it is a standard result in econometrics that regression on the lagged value of the dependent variable is biased in finite samples. Since a fundamental such as the price/​dividend ratio is a statistical proxy for lagged price, predictive regressions are potentially subject to a corresponding small sample bias. This may create the illusion that one can buy low and sell high in the sample even if the relationship is useless for forecasting. Second, multiperiod returns are positively autocorrelated by construction, raising the possibility of spurious regression. Standard errors which are computed from the asymptotic formula may not be large enough in small samples. A set of Monte Carlo experiments are presented in which data are generated by a version of the present value model in which the discount rate is constant so returns are not in fact predictable. We show that a number of the characteristica of the historical results can be replicated simply by the combined effects of the two small sample biases.
  • RePEc:nbr:nberwo:3297
Language
  • English
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