Expected Returns Across Time Scales

This paper studies the role of ‡uctuations in the aggregate price-earning ratio at di¤erent time scales for predicting stock returns and explore the channels through which returns are predicted. Using U.S. quarterly and international monthly data, we …nd that cycles in the price-earning ratio are strong and better predictors of future returns at short and intermediate horizons than the aggregate price-earning ratio and several other popular forecasting variables. Moreover, this predictability is economically pro…table. The proposed method, based on a wavelet multiscaling method, explicitly accounts for the variations at di¤erent time scales in expected cash-‡ow growth and expected returns. JEL Classi…cation: G12, C32, C53. Keywords: Financial ratios, return predictability, cycles, wavelets. A.A .Advisors-QCG (ABN AMRO), Variances and University of Paris-1 (CES/CNRS). Corresp ondance to: Christophe Boucher, CES/CNRS, MSE, 106 bv de l’hôp ita l F -75647 Paris cedex 13. Tel: +33 144078189. E -mail: christophe.b oucher@univ-paris1 .fr. y A.A .Advisors-QCG (ABN AMRO), Variances and University of Paris-1 (CES/CNRS and EIF). E -mail: bmaillet@univ-paris1 .fr. z The second author thanks the Europlace Institute of F inance for …nancia l support. P relim inary version (work in progress): do not quote or circu late w ithout an explic it p erm ission . The usual d iscla im ers apply.