Predictive Systems: Living with Imperfect Predictors

Lubos Pastor and Robert Stambaugh

No 13804, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We develop a framework for estimating expected returns—a predictive system —that allows predictors to be imperfectly correlated with the conditional expected return. When predictors are imperfect, the estimated expected return depends on past returns in a manner that hinges on the correlation between unexpected returns and innovations in expected returns. We find empirically that prior beliefs about this correlation, which is most likely negative, substantially affect estimates of expected returns as well as various inferences about predictability, including assessments of a predictor's usefulness. Compared to standard predictive regressions, predictive systems deliver different and more precise estimates of expected returns.

JEL-codes: G1 G11 G12 (search for similar items in EconPapers)
Date: 2008-02
New Economics Papers: this item is included in nep-ecm
Note: AP
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Citations: View citations in EconPapers (6)

Published as Lubos Pástor & Robert F. Stambaugh, 2009. "Predictive Systems: Living with Imperfect Predictors," Journal of Finance, American Finance Association, vol. 64(4), pages 1583-1628, 08.

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Related works:
Journal Article: Predictive Systems: Living with Imperfect Predictors (2009)
Working Paper: Predictive Systems: Living with Imperfect Predictors (2007)
Working Paper: Predictive Systems: Living with Imperfect Predictors (2007)
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