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The Optimal Use of Return Predictability: An Empirical Study

Published online by Cambridge University Press:  04 October 2012

Abhay Abhyankar ,
Devraj Basu  and
Alexander Stremme
Abhay Abhyankar
Affiliation:
[email protected], Business School, University of Exeter, Rennes Drive, Exeter EX4 4PU, UK
Devraj Basu
Affiliation:
[email protected], SKEMA Business School, 06902 Sophia Antipolis Cedex, France
Alexander Stremme
Affiliation:
[email protected], Warwick Business School, University of Warwick, Coventry CV4 7AL, UK
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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.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 47 , Issue 5 , October 2012 , pp. 973 - 1001
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2012

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