Why Are Asset Returns Predictable?

Lüders, Erik

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URL: http://ub-madoc.bib.uni-mannheim.de/397
URN: urn:nbn:de:bsz:180-madoc-3970
Document Type: Working paper
Year of publication: 2002
The title of a journal, publication series: None
Publication language: English
Institution: Sonstige Einrichtungen > ZEW - Leibniz-Zentrum für Europäische Wirtschaftsforschung
MADOC publication series: Veröffentlichungen des ZEW (Leibniz-Zentrum für Europäische Wirtschaftsforschung) > ZEW Discussion Papers
Subject: 330 Economics
Classification: JEL: G12 ,
Subject headings (SWD): Preisgleichgewicht , Autokorrelation , Marktergebnis
Abstract: Starting from an information process governed by a geometric Brownian motion we show that asset returns are predictable if the elasticity of the pricing kernel is not constant. Declining [Increasing] elasticity of the pricing kernel leads to mean reversion and negatively autocorrelated asset returns [mean aversion and positively autocorrelated asset returns]. Under nonconstant elasticity of the pricing kernel financial ratios as the price-earnings ratio have predicitve power for future asset returns. In addition, it is shown that asset prices will be governed by a time-homogeneous stochastic differential equation only under the constant elasticity pricing kernel. Hence, usually asset price processes do not satisfy the assumptions needed for empirical estimation.
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