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Simple Forecasts and Paradigm Shifts
Author(s) -
HONG HARRISON,
STEIN JEREMY C.,
YU JIALIN
Publication year - 2007
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/j.1540-6261.2007.01234.x
Subject(s) - univariate , econometrics , skewness , volatility (finance) , simple (philosophy) , economics , multivariate statistics , stock (firearms) , financial economics , mathematics , statistics , geography , philosophy , archaeology , epistemology
We study the asset pricing implications of learning in an environment in which the true model of the world is a multivariate one, but agents update only over the class of simple univariate models. Thus, if a particular simple model does a poor job of forecasting over a period of time, it is discarded in favor of an alternative simple model. The theory yields a number of distinctive predictions for stock returns, generating forecastable variation in the magnitude of the value‐glamour return differential, in volatility, and in the skewness of returns. We validate several of these predictions empirically.