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Assessing the Economic Significance of Return Predictability: A Research Note

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  • Walter Boudry
  • Philip Gray

Abstract

The predictability of stock returns is often assessed using classical statistical significance from predictive regressions. Statistical inference, however, can belie the economic importance with which investors regard various predictors. This paper examines the influence that predictors have on an investor's optimal portfolio allocations. The results show that return predictability is sufficient to induce horizon effects in optimal allocations. After incorporating estimation risk, however, little evidence of predictability remains. We also assess the relative importance of three predictor variables. While dividend yield is the most important predictor, optimal allocations are also sensitive to the term spread and the relative bill rate.

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  • Walter Boudry & Philip Gray, 2003. "Assessing the Economic Significance of Return Predictability: A Research Note," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 30(9‐10), pages 1305-1326, December.
  • Handle: RePEc:bla:jbfnac:v:30:y:2003:i:9-10:p:1305-1326
    DOI: 10.1111/j.0306-686X.2003.05482.x
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    References listed on IDEAS

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    1. John Y. Campbell & Luis M. Viceira, 1999. "Consumption and Portfolio Decisions when Expected Returns are Time Varying," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 114(2), pages 433-495.
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    Cited by:

    1. GIOT, Pierre & PETITJEAN, Mikael, 2005. "Dynamic asset allocation between stocks and bonds using the Bond-Equity Yield Ratio," LIDAM Discussion Papers CORE 2005010, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
    2. Jurdi, Doureige J., 2022. "Predicting the Australian equity risk premium," Pacific-Basin Finance Journal, Elsevier, vol. 71(C).
    3. Yiwen (Paul) Dou & David R. Gallagher & David Schneider & Terry S. Walter, 2012. "Out-of-sample stock return predictability in Australia," Australian Journal of Management, Australian School of Business, vol. 37(3), pages 461-479, December.
    4. Philip Gray, 2008. "Economic significance of predictability in Australian equities," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 48(5), pages 783-805, December.
    5. Javier Gil‐Bazo, 2006. "Investment Horizon Effects," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 33(1‐2), pages 179-202, January.
    6. Jamie Alcock & Philip Gray, 2005. "Forecasting Stock Returns Using Model‐Selection Criteria," The Economic Record, The Economic Society of Australia, vol. 81(253), pages 135-151, June.

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