The Dog That Did Not Bark: A Defense of Return Predictability / John H. Cochrane.

Format:

Book

Author/Creator:

Cochrane, John H.

Contributor:

National Bureau of Economic Research.

Series:

Working Paper Series (National Bureau of Economic Research) no. w12026.

NBER working paper series no. w12026

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Other Title:

The Dog That Did Not Bark

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2006.

Summary:

To question the statistical significance of return predictability, we cannot specify a null that simply turns off that predictability, leaving dividend growth predictability at its essentially zero sample value. If neither returns nor dividend growth are predictable, then the dividend-price ratio is a constant. If the null turns off return predictability, it must turn on the predictability of dividend growth, and then confront the evidence against such predictability in the data. I find that the absence of dividend growth predictability gives much stronger statistical evidence against the null, with roughly 1-2% probability values, than does the presence of return predictability, which only gives about 20% probability values. I argue that tests based on long-run return and dividend growth regressions provide the cleanest and most interpretable evidence on return predictability, again delivering about 1-2% probability values against the hypothesis that returns are unpredictable. I show that Goyal and Welch's (2005) finding of poor out-of-sample R2 does not reject return forecastability. Out-of-sample R2 is poor even if all dividend yield variation comes from time-varying expected returns.

Notes:

Print version record

February 2006.