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Are financial returns really predictable out-of-sample?: Evidence from a new bootstrap test

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  • Liu, Li
  • Bu, Ruijun
  • Pan, Zhiyuan
  • Xu, Yuhua

Abstract

Testing the out-of-sample return predictability is of great interest among academics. A wide range of studies have shown the predictability of stock returns, but fail to test the statistical significance of economic gains from the predictability. In this paper, we develop a new statistical test for the directional accuracy of stock returns. Monte Carlo experiments reveal that our bootstrap-based tests have more correct size and better power than the existing tests. We use the forecast combinations and find that the stock return predictability is statistically significant in terms of reduction of mean squared predictive error relative to the benchmark of historical average forecasts. However, the results from our tests show that the predictability is not economically significant. We conclude that there will be still a long way to go for forecasting stock returns for market participants.

Suggested Citation

  • Liu, Li & Bu, Ruijun & Pan, Zhiyuan & Xu, Yuhua, 2019. "Are financial returns really predictable out-of-sample?: Evidence from a new bootstrap test," Economic Modelling, Elsevier, vol. 81(C), pages 124-135.
    • Handle: RePEc:eee:ecmode:v:81:y:2019:i:c:p:124-135
    DOI: 10.1016/j.econmod.2018.12.014
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