A formula for the economic value of return predictability

摘要

This paper provides a formula for a commonly used measure of the economic value of asset return predictability. In doing this, we find that there is a strong connection between this measure and a traditional statistical measure of predictive quality. In particular, we demonstrate that the maximum amount an investor is willing to pay for predictability knowledge (the performance fee) is a simple transformation of the R2 statistic associated with the predictor equation. We illustrate the use of these results with an application to the Ibbotson US bond and equity data (and a set of pertinent predictors), and via application to the results published in Fama and French [1988. Dividend yields and expected stock returns. Journal of Financial Economics 22: 3-25], Balvers, Cosimano, and McDonald [1990. Predicting stock returns in an efficient market. Journal of Finance 45: 1109-28], Lettau and Ludvigson [2001. Consumption, aggregate wealth and expected stock returns. Journal of Finance 56: 815-49], and Santa-Clara and Yan [2010. Crashes, volatility, and the equity premium: Lessons from S&P 500 options. Review of Economics and Statistics 92:435-51].