TY  - JOUR
AU  - Cochrane,John H.
TI  - The Dog That Did Not Bark: A Defense of Return Predictability
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 12026
PY  - 2006
Y2  - February 2006
UR  - http://www.nber.org/papers/w12026
L1  - http://www.nber.org/papers/w12026.pdf
N1  - Author contact info:
John H. Cochrane
Booth School of Business
University of Chicago
5807 S. Woodlawn
Chicago, IL  60637
Tel: 773/702-3059
Fax: 773/702-0458
E-Mail: john.cochrane@chicagobooth.edu
AB  - To question the statistical significance of return predictability, we cannot specify a null that simply turns off that predictability, leaving dividend growth predictability at its essentially zero sample value. If neither returns nor dividend growth are predictable, then the dividend-price ratio is a constant. If the null turns off return predictability, it must turn on the predictability of dividend growth, and then confront the evidence against such predictability in the data. I find that the absence of dividend growth predictability gives much stronger statistical evidence against the null, with roughly 1-2% probability values, than does the presence of return predictability, which only gives about 20% probability values. I argue that tests based on long-run return and dividend growth regressions provide the cleanest and most interpretable evidence on return predictability, again delivering about 1-2% probability values against the hypothesis that returns are unpredictable. I show that Goyal and Welch's (2005) finding of poor out-of-sample R2 does not reject return forecastability. Out-of-sample R2 is poor even if all dividend yield variation comes from time-varying expected returns.
ER  -