Publication: Regime specific predictability in predictive regressions
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2010-12
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Abstract
Predictive regressions are linear specifications linking a noisy variable such as stock returns
to past values of a more persistent regressor with the aim of assessing the presence of
predictability. Key complications that arise are the potential presence of endogeneity and the
poor adequacy of asymptotic approximations. In this paper we develop tests for uncovering
the presence of predictability in such models when the strength or direction of predictability
may alternate across different economically meaningful episodes. An empirical application
reconsiders the Dividend Yield based return predictability and documents a strong
predictability that is countercyclical, occurring solely during bad economic times.
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Endogeneity, Persistence, Return predictability, Threshold models