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The scale of predictability

F.M. Bandi, B. Perron, A. Tamoni and C. Tebaldi

Journal of Econometrics, 2019, vol. 208, issue 1, 120-140

Abstract: We introduce a new stylized fact: the hump-shaped behavior of slopesand coefficients of determination as a function of the aggregation horizon when running (forward/backward) predictive regressions of future excess market returns onto past economic uncertainty (as proxied by market variance, consumption variance, or economic policy uncertainty). To justify this finding formally, we propose a novel modeling framework in which predictability is specified as a property of components of both excess market returns and economic uncertainty. We dub this property scale-specific predictability. We show that classical predictive systems imply restricted forms of scale-specific predictability. We conclude that for certain predictors, like economic uncertainty, the restrictions imposed by classical predictive systems may be excessively strong.

Keywords: Predictability; Frequency; Aggregation; Risk-return trade-off (search for similar items in EconPapers)
JEL-codes: C22 E32 E44 G12 G17 (search for similar items in EconPapers)
Date: 2019
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