International stock return predictability: Evidence from new statistical tests

Abstract

We investigate whether stock returns of international markets are predictable from a range of fundamentals including key financial ratios (dividend-price ratio, dividend-yield, earnings-price ratio, dividend-payout ratio), technical indicators (price pressure, change in volume), and short-term interest rates. We adopt two new alternative testing and estimation methods: the improved augmented regression method and wild bootstrapping of predictive model based on a restricted VAR form. Both methods take explicit account of endogeneity of predictors, providing bias-reduced estimation and improved statistical inference in small samples. From monthly data of 16 Asia-Pacific (including U.S.) and 21 European stock markets from 2000 to 2014, we find that the financial ratios show weak predictive ability with small effect sizes and poor out-of-sample forecasting performances. In contrast, the price pressure and interest rate are found to be strong predictors for stock return with large effect sizes and satisfactory out-of-sample forecasting performance.