Temporary Components of Stock Returns: What Do the Data Tell Us?

Within the past few years several articles have suggested that returns on large equity portfolios may contain a significant predictable component at horizons three to six years. Subsequently, the tests used in these analyses have been criticized (appropriately) for having widely misunderstood size and power, rendering the conclusions inappropriate. This criticism, however, has not focused on the data, it addresses the properties of the tests. In this article we adopt a subjectivist analysis--treating the data as fixed--to ascertain whether the data have anything to say about the permanent-temporary decomposition. The data speak clearly and they tell us that for all intents and purposes, stock prices follow a random walk. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.