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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:
a.abhyankar@exeter.ac.uk, Business School, University of Exeter, Rennes Drive, Exeter EX4 4PU, UK
Devraj Basu
Affiliation:
devraj.basu@skema.edu, SKEMA Business School, 06902 Sophia Antipolis Cedex, France
Alexander Stremme
Affiliation:
alex.stremme@wbs.ac.uk, 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.

Information

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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