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Maximal predictability under long-term mean reversion

Erik Hjalmarsson

Journal of Empirical Finance, 2018, vol. 45, issue C, 269-282

Abstract: I analyse the relationship between two stylized empirical facts for stock returns: Unconditional long-term mean reversion and predictability by variables such as the dividend-price ratio or the short-term interest rate. In particular, I show that if one imposes that returns satisfy long-term mean reversion, this implies an upper bound on the predictive regression R-square. If a predictive regression is intended as a motivational building block for theoretical modelling, and the R-square bound is violated, one should recognize that the implied returns process violate long-term mean reversion. Empirical results show that the proposed bound is binding for several leading predictors.

Keywords: Return predictability; Variance ratios (search for similar items in EconPapers)
JEL-codes: C22 G1 (search for similar items in EconPapers)
Date: 2018
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Journal of Empirical Finance is currently edited by R. T. Baillie, F. C. Palm, Th. J. Vermaelen and C. C. P. Wolff

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Handle: RePEc:eee:empfin:v:45:y:2018:i:c:p:269-282