State-Switching Return Predictability
نویسنده
چکیده
Return predictability may be hidden from view if the same information has different meanings at different times, especially if information is good news in one state but bad news in another. We illustrate, using price changes in industrial metals, how conclusions on stock market return predictability vary with the number of expansions and contractions in our sample. We also show how state-switching affects predictability results in other studies. Even one strong contraction, like the recent financial crisis, in a sample can fundamentally alter overall conclusions. Since traditional regression tests ignore state-switching, standard tests may favor market efficiency.
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