Predicting Stock Returns in an Efficient Market
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An intertemporal general equilibrium model relates financial asset
returns to movements in aggregate output. The model is a standard
neoclassical growth model with serial correlation in aggregate output.
Changes in aggregate output lead to attempts by agents to smooth
consumption, which affects the required rate of return on financial
assets. Since aggregate output is serially correlated and, hence,
predictable, the theory suggests that stock returns can be predicted based
on rational forecasts of output. The empirical results confirm that stock
returns are a predictable function of aggregate output and also support
the accompanying implications of the model.
Copyright 1990 by American Finance Association.
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