Testing predictability of stock returns under possible bubbles

Bingduo Yang, Wei Long and Zihui Yang

Journal of Empirical Finance, 2022, vol. 68, issue C, 246-260

Abstract: This study reexamines stock return predictability via several financial variables and an investor sentiment index. We develop an IVX bubble-based Wald statistic (IVX-BUB) which extends the IVX-based test (IVX-KMS) proposed by Kostakis, Magdalinos and Stamatogiannis (2015) and accounts for the potential bubble effect in the predictive regression. Simulation results indicate that IVX-BUB performs reasonably well when bubbles exist, while IVX-KMS displays severe size distortion in highly persistent predictors. In the empirical study, we consider the monthly excess returns of S&P 500 during 1927–2016 and identify six bubble episodes using the real-time date-stamping strategy proposed by Phillips, Shi and Yu (2015a, 2015b). The empirical results show that IVX-BUB produces fewer significant individual predictors and their combinations than IVX-KMS, but both methods provide evidence in favor of the strong predictive ability of the investor sentiment index.

Keywords: Bubble; Hypothesis test; IVX; Predictive regression (search for similar items in EconPapers)
JEL-codes: C12 C22 (search for similar items in EconPapers)
Date: 2022
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Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:empfin:v:68:y:2022:i:c:p:246-260

DOI: 10.1016/j.jempfin.2022.07.010

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