What Is The Chance That The Equity Premium Varies Over Time? Evidence From Predictive Regressions

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Executive Summary

This paper examines the evidence on stock return predictability in a Bayesian setting that includes uncertainty about both the existence and strength of predictability. The author considers an investor who believes that excess stock returns exhibit predictability with prior probability q < 1. In addition, the investor down weights observed predictability by placing a prior distribution on the R2 of the predictability regression. When applied with analysis to the dividend-price ratio, it's found that even investors who are quite skeptical about the existence and strength of predictability sharply modify their views in favor of predictability when confronted by the evidence.

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