TY  - JOUR
AU  - Pastor,Lubos
AU  - Stambaugh,Robert F.
TI  - Predictive Systems: Living with Imperfect Predictors
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 12814
PY  - 2007
Y2  - January 2007
UR  - http://www.nber.org/papers/w12814
L1  - http://www.nber.org/papers/w12814.pdf
N1  - Author contact info:
Lubos Pastor
University of Chicago
Booth School of Business
5807 South Woodlawn Ave
Chicago, IL  60637
Tel: 773/834-4080
Fax: NA
E-Mail: lubos.pastor@chicagobooth.edu

Robert F. Stambaugh
Finance Department
The Wharton School
University of Pennsylvania
Philadelphia, PA   19104-6367
Tel: 215/898-5734
Fax: 215/898-6200
E-Mail: stambaugh@wharton.upenn.edu
AB  - The standard regression approach to modeling return predictability seems too restrictive in one way but too lax in another.  A predictive regression models expected returns as an exact linear function of a given set of predictors but does not exploit the likely economic property that innovations in expected returns are negatively correlated with unexpected returns.  We develop an alternative framework - a predictive system - that accommodates imperfect predictors and beliefs about that negative correlation.  In this framework, the predictive ability of imperfect predictors is supplemented by information in lagged returns as well as lags of the predictors.  Compared to predictive regressions, predictive systems deliver different and substantially more precise estimates of expected returns as well as different assessments of a given predictor's usefulness.
ER  -