Predictable return distributions

Thomas Pedersen ()

CREATES Research Papers from Department of Economics and Business Economics, Aarhus University

Abstract: This paper provides detailed insights into predictability of the entire stock and bond return distribution through the use of quantile regression. This allows us to examine speci?c parts of the return distribution such as the tails or the center, and for a suf?ciently ?ne grid of quantiles we can trace out the entire distribution. A univariate quantile regression model is used to examine stock and bond return distributions individually, while a multivariate model is used to capture their joint distribution. An empirical analysis on US data shows that certain parts of the return distributions are predictable as a function of economic state variables. The results are, however, very different for stocks and bonds. The state variables primarily predict only location shifts in the stock return distribution, while they also predict changes in higher-order moments in the bond return distribution. Out-of-sample analyses show that the relative accuracy of the state variables in predicting future returns varies across the distribution. A portfolio study shows that an investor with power utility can obtain economic gains by applying the empirical return distribution in portfolio decisions instead of imposing an assumption of lognormally distributed returns.

Keywords: Return predictability; return distribution; quantile regression; multivariate model; out-of-sample forecast; portfolio choice (search for similar items in EconPapers)
JEL-codes: C21 C31 G11 G12 G17 (search for similar items in EconPapers)
Pages: 47
Date: 2010-07-01
New Economics Papers: this item is included in nep-ecm and nep-for
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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