Taking Stock of Long-Horizon Predictability Tests: Are Factor Returns Predictable?

108 Pages Posted: 20 Nov 2018

See all articles by Alexandros Kostakis

Alexandros Kostakis

University of Liverpool - Management School (ULMS); The University of Manchester - Manchester Business School

Tassos Magdalinos

University of Southampton

Michalis P. Stamatogiannis

University of Liverpool Management School

Date Written: October 30, 2018

Abstract

This study provides a critical assessment of long-horizon return predictability tests using highly persistent regressors. We show that the most commonly used test statistics are typically oversized, leading to spurious inference. As a remedy, we propose a simple Wald statistic, which can accommodate multiple predictors, exhibits excellent finite-sample properties regardless of the length of the predictive horizon, and is robust to the (unobservable) exact time series properties of the employed predictor(s). Employing this test statistic and examining a small set of variables that have been commonly used as proxies for business cycle conditions, we find evidence of predictability for "old" and "new" pricing factors with monthly returns. However, this evidence becomes weaker, not stronger, as the predictive horizon increases and disappears for most of the factors with annual returns. Overall, we cast doubt on the incremental value of using long-horizon predictive regressions.

Keywords: Long-Horizon Predictive Regressions, Persistent Regressors, Factor Returns

Suggested Citation

Kostakis, Alexandros and Magdalinos, Tassos and Stamatogiannis, Michalis P., Taking Stock of Long-Horizon Predictability Tests: Are Factor Returns Predictable? (October 30, 2018). Available at SSRN: https://ssrn.com/abstract=3284149 or http://dx.doi.org/10.2139/ssrn.3284149

Alexandros Kostakis (Contact Author)

University of Liverpool - Management School (ULMS) ( email )

Chatham Building
Liverpool, L69 7ZH
United Kingdom

HOME PAGE: http://www.alexkostakis.com

The University of Manchester - Manchester Business School ( email )

Booth Street West
Manchester, M15 6PB
United Kingdom

Tassos Magdalinos

University of Southampton ( email )

University Rd.
Southampton SO17 1BJ, Hampshire SO17 1LP
United Kingdom

Michalis P. Stamatogiannis

University of Liverpool Management School ( email )

Chatham Street
Liverpool, L69 7ZH
United Kingdom

HOME PAGE: http://https://www.liverpool.ac.uk/management/staff/michail-stamatogiannis/

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