Working Paper: CEPR ID: DP3997
Authors: Marco Aiolfi; Carlo A. Favero
Abstract: Recent financial research has provided evidence on the predictability of asset returns. In this Paper we consider the results contained in Pesaran-Timmerman (1995), which provided evidence on predictability of excess returns in the US stock market over the sample 1959-92. We show that the extension of the sample to the nineties weakens considerably the statistical and economic significance of the predictability of stock returns based on earlier data. We propose an extension of their framework, based on the explicit consideration of model uncertainty under rich parameterizations for the predictive models. We propose a novel methodology to deal with model uncertainty based on ?thick? modelling, i.e. considering a multiplicity of predictive models rather than a single predictive model. We show that portfolio allocations based on a thick modeling strategy systematically outperform thin modelling.
Keywords: model uncertainty; thick modelling; predictability of stock returns
JEL Codes: C53; G11
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| model uncertainty (D80) | predictability of stock returns (G17) |
| modelling approaches (C59) | predictability of excess stock returns (G17) |
| thick modelling (C59) | portfolio allocations (G11) |
| thick modelling (C59) | performance of portfolios based on thick modelling (G11) |
| thin modelling (Y60) | performance of portfolios based on thin modelling (G11) |
| sample period extension (C41) | predictability of excess stock returns (G17) |