Efficient tests of stock return predictability

John Y. Campbell, Motohiro Yogo

Research output: Contribution to journalArticle

347 Scopus citations

Abstract

Conventional tests of the predictability of stock returns could be invalid, that is reject the null too frequently, when the predictor variable is persistent and its innovations are highly correlated with returns. We develop a pretest to determine whether the conventional t-test leads to invalid inference and an efficient test of predictability that corrects this problem. Although the conventional t-test is invalid for the dividend-price and smoothed earnings-price ratios, our test finds evidence for predictability. We also find evidence for predictability with the short rate and the long-short yield spread, for which the conventional t-test leads to valid inference.

Original languageEnglish (US)
Pages (from-to)27-60
Number of pages34
JournalJournal of Financial Economics
Volume81
Issue number1
DOIs
StatePublished - Jul 2006

All Science Journal Classification (ASJC) codes

  • Accounting
  • Finance
  • Economics and Econometrics
  • Strategy and Management

Keywords

  • Bonferroni test
  • Dividend yield
  • Predictability
  • Stock returns
  • Unit root

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