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A STATE‐SPACE MODEL OF SHORT‐ AND LONG‐HORIZON STOCK RETURNS
Author(s) -
Zhou Chunsheng,
Qing Chang
Publication year - 2000
Publication title -
journal of financial research
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.319
H-Index - 49
eISSN - 1475-6803
pISSN - 0270-2592
DOI - 10.1111/j.1475-6803.2000.tb00758.x
Subject(s) - econometrics , stock (firearms) , economics , dividend , horizon , decile , financial economics , state space , mathematics , statistics , finance , geography , geometry , archaeology
In this article we propose a new parsimonious state‐space model in which state variables characterize the stochastic movements of stock returns. Using the equally weighted and decile monthly stock returns, we show that (a) a parsimonious state‐space model characterizes the variation in expected returns at any horizon; (b) the extracted expected returns explain a substantial proportion of the variance in realized returns, and the magnitude of this proportion increases significantly with the horizon of returns; (c) the model successfully captures the empirical fact that returns of smaller firms have both stronger positive autocorrelations of short‐horizon returns and stronger negative autocorrelations of long‐horizon returns; and (d) the forecasts of asset returns obtained with the state‐space model subsume the information in other potential predictor variables such as dividend yields. JEL classification: G10, G12.