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Efficient Tests of Stock Return Predictability

By John Y. Campbell and Motohiro Yogo

Abstract

Tests of the predictability of stock returns may be invalid when the predictor variable is persistent and its innovations are highly correlated with returns. This paper develops a pretest to determine whether the conventional t-test leads to incorrect inference and an efficient test of predictability that always leads to correct inference. Although the conventional t-test is highly misleading for the dividend-price and the smoothed earnings-price ratios, we find evidence for predictability using our test. We also find evidence for predictability with the short rate and the long-short yield spread, for which the conventional t-test leads to correct inference

Topics: Bonferroni, Dividend yield, Predictability, Stock returns, Unit root
Year: 2002
OAI identifier: oai:CiteSeerX.psu:10.1.1.199.1532
Provided by: CiteSeerX
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