The Optimal Use of Return Predictability: An Empirical Study

Abhay Abhyankar, Devraj Basu and Alexander Stremme

Journal of Financial and Quantitative Analysis, 2012, vol. 47, issue 5, 973-1001

Abstract: In this paper we study the economic value and statistical significance of asset return predictability, based on a wide range of commonly used predictive variables. We assess the performance of dynamic, unconditionally efficient strategies, first studied by Hansen and Richard (1987) and Ferson and Siegel (2001), using a test that has both an intuitive economic interpretation and known statistical properties. We find that using the lagged term spread, credit spread, and inflation significantly improves the risk-return trade-off. Our strategies consistently outperform efficient buy-and-hold strategies, both in and out of sample, and they also incur lower transactions costs than traditional conditionally efficient strategies.

Date: 2012
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