A formula for the economic value of return predictability

Taylor, Nick James 2013. A formula for the economic value of return predictability. The European Journal of Finance 19 (1) , pp. 37-53. 10.1080/1351847X.2011.640340

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Abstract

This paper provides a formula for a commonly used measure of the economic value of asset return predictability. In doing this, we find that there is a strong connection between this measure and a traditional statistical measure of predictive quality. In particular, we demonstrate that the maximum amount an investor is willing to pay for predictability knowledge (the performance fee) is a simple transformation of the R 2 statistic associated with the predictor equation. We illustrate the use of these results with an application to the Ibbotson US bond and equity data (and a set of pertinent predictors), and via application to the results published in Fama and French [1988. Dividend yields and expected stock returns. Journal of Financial Economics 22: 3–25], Balvers, Cosimano, and McDonald [1990. Predicting stock returns in an efficient market. Journal of Finance 45: 1109–28], Lettau and Ludvigson [2001. Consumption, aggregate wealth and expected stock returns. Journal of Finance 56: 815–49], and Santa-Clara and Yan [2010. Crashes, volatility, and the equity premium: Lessons from S&P 500 options. Review of Economics and Statistics 92: 435–51].

Item Type:	Article
Date Type:	Publication
Status:	Published
Schools:	Business (Including Economics)
Subjects:	H Social Sciences > HB Economic Theory H Social Sciences > HG Finance
Uncontrolled Keywords:	economic value; predictability; performance fees.
Additional Information:	Available online: 06 Feb 2012
Publisher:	Taylor and Francis
ISSN:	1351-847X
Last Modified:	25 Jun 2017 02:40
URI:	https://orca.cardiff.ac.uk/id/eprint/17731

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