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RFS Advance Access published online on September 22, 2007
Review of Financial Studies, doi:10.1093/rfs/hhm046
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Copyright © The Author 2007. Published by Oxford University Press on behalf of The Society for Financial Studies.

The Dog That Did Not Bark: A Defense of Return Predictability

John H. Cochrane
University of Chicago GSB and NBER

Address correspondence to John H. Cochrane, Graduate School of Business, 5807 S. Woodlawn, Chicago IL 60637, 773 702 3059, or e-mail: john.cochrane{at}chicagogsb.edu

JEL: G12, G14, C22


  Abstract

If returns are not predictable, dividend growth must be predictable, to generate the observed variation in divided yields. I find that the absence of dividend growth predictability gives stronger evidence than does the presence of return predictability. Long-horizon return forecasts give the same strong evidence. These tests exploit the negative correlation of return forecasts with dividend-yield autocorrelation across samples, together with sensible upper bounds on dividend-yield autocorrelation, to deliver more powerful statistics. I reconcile my findings with the literature that finds poor power in long-horizon return forecasts, and with the literature that notes the poor out-of-sample R2 of return-forecasting regressions.

I acknowledge research support from CRSP and from a NSF grant administered by the NBER. I thank Alan Bester, John Campbell, John Heaton, Lars Hansen, Anil Kashyap, Sydney Ludvigson, Lubos Pastor, Ivo Welch, and an anonymous referee for very helpful comments.


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