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Appears in Collections:Economics Journal Articles
Peer Review Status: Refereed
Title: Stock return predictability: the role of inflation and threshold dynamics
Author(s): McMillan, David
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Keywords: Stock returns
JEL Codes: C22, G12
Issue Date: 2017
Citation: McMillan D (2017) Stock return predictability: the role of inflation and threshold dynamics, International Review of Applied Economics, 31 (3), pp. 357-375.
Abstract: This paper argues that the nature of stock return predictability varies with the level of inflation. We contend that the nature of relations between economic variables and returns differs according to the level of inflation, due to different economic risk implications. An increase in low level inflation may signal improving economic conditions and lower expected returns, while the opposite is true with an equal rise in high level inflation. Linear estimation provides contradictory coefficient values, which we argue arises from mixing coefficient values across regimes. We test for and estimate threshold models with inflation and the term structure as the threshold variable. These models reveal a change in either the sign or magnitude of the parameter values across the regimes such that the relation between stock returns and economic variables is not constant. Measures of in-sample fit and a forecast exercise support the threshold models. They produce a higher adjustedR2, lower MAE and RMSE and higher trading related measures. These results help explain the lack of consistent empirical evidence in favour of stock return predictability and should be of interest to those engaged in stock market modelling as well as trading and portfolio management.
DOI Link: 10.1080/02692171.2016.1257581
Rights: This item has been embargoed for a period. During the embargo please use the Request a Copy feature at the foot of the Repository record to request a copy directly from the author. You can only request a copy if you wish to use this work for your own research or private study. This is an Accepted Manuscript of an article published by Taylor & Francis Group in International Review of Applied Economics on 22 Nov 2016, available online:

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