NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Maximizing Predictability in the Stock and Bond Markets

Andrew W. Lo, A. Craig MacKinlay

NBER Working Paper No. 5027*
Issued in February 1995
NBER Program(s):   AP

We construct portfolios of stocks and of bonds that are maximally predictable with respect to a set of ex ante observable economic variables, and show that these levels of predictability are statistically significant, even after controlling for data-snooping biases. We disaggregate the sources for predictability by using several asset groups, including industry-sorted portfolios, and find that the sources of maximal predictability shift considerably across asset classes and sectors as the return-horizon changes. Using three out-of-sample measures of predictability, we show that the predictability of the maximally predictable portfolio is genuine and economically significant.

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