Predictability in International Asset Returns: A Reexamination

The views expressed are those of the authors and do not necessarily reflect official positions of the Federal Reserve Bank of St. Louis, or the Federal Reserve System. The authors wish to thank Robert Hodrick for supplying the data used in Bekaert and Hodrick (1992), Morgan Stanley for providing us with additional financial data and Kent Koch for excellent research assistance. We also thank Chuck Whiteman, Dick Anderson, Bob Rasche, Gene Savin and Dan Thornton for helpful comments and Robert Hodrick and Paul Sengmuller both for helpful comments and for pointing out an error in one of our programs. Paul Weller would like to thank the Research Department of the Federal Reserve Bank of St. Louis for its hospitality during his stay as a Visiting Scholar, when this work was initiated. This paper argues that inferring long-horizon asset-return predictability from the properties of vector autoregressive (VAR) models on relatively short spans of data is potentially unreliable. We illustrate the problems that can arise by re-examining the findings of Bekaert and Hodrick (1992), who detected evidence of in-sample predictability in international equity and foreign exchange markets using VAR methodology for a variety of countries over the perio