Working Paper: CEPR ID: DP5770
Authors: Philippe Bacchetta; Elmar Mertens; Eric van Wincoop
Abstract: There is widespread evidence of excess return predictability in financial markets. In this paper we examine whether this predictability is related to expectational errors. To consider this issue, we use data on survey expectations of market participants in the stock market, the foreign exchange market, and the bond and money markets in various countries. We find that the predictability of expectational errors coincides with the predictability of excess returns: when a variable predicts expectational errors in a given market, it typically predicts the excess return as well. Understanding expectational errors appears crucial for explaining excess return predictability.
Keywords: excess returns; expectations; survey; predictability
JEL Codes: F31; G12; G14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Predictability of expectational errors (D84) | Predictability of excess returns (G17) |
| Interest differential (E43) | Predictability of expectational errors (D84) |
| Interest differential (E43) | Predictability of excess returns (G17) |
| Predictability of excess returns in money market (E47) | Predictability of expectational errors in money market (E47) |