Download or read book Essays on the Predictability and Volatility of Asset Returns written by Stefan A. Jacewitz and published by . This book was released on 2010 with total page pages. Available in PDF, EPUB and Kindle. Book excerpt: This dissertation collects two papers regarding the econometric and economic theory and testing of the predictability of asset returns. It is widely accepted that stock returns are not only predictable but highly so. This belief is due to an abundance of existing empirical literature finding often overwhelming evidence in favor of predictability. The common regressors used to test predictability (e.g., the dividend-price ratio for stock returns) are very persistent and their innovations are highly correlated with returns. Persistence when combined with a correlation between innovations in the regressor and asset returns can cause substantial over-rejection of a true null hypothesis. This result is both well documented and well known. On the other hand, stochastic volatility is both broadly accepted as a part of return time series and largely ignored by the existing econometric literature on the predictability of returns. The severe effect that stochastic volatility can have on standard tests are demonstrated here. These deleterious effects render standard tests invalid. However, this problem can be easily corrected using a simple change of chronometer. When a return time series is read in the usual way, at regular intervals of time (e.g., daily observations), then the distribution of returns is highly non-normal and displays marked time heterogeneity. If the return time series is, instead, read according to a clock based on regular intervals of volatility, then returns will be independent and identically normally distributed. This powerful result is utilized in a unique way in each chapter of this dissertation. This time-deformation technique is combined with the Cauchy t-test and the newly introduced martingale estimation technique. This dissertation finds no evidence of predictability in stock returns. Moreover, using martingale estimation, the cause of the Forward Premium Anomaly may be more easily discerned.