DP5770 Predictability in Financial Markets: What Do Survey Expectations Tell Us?

Author(s): Philippe Bacchetta, Elmar Mertens, Eric van Wincoop
Publication Date: July 2006
Keyword(s): excess returns, expectations survey, predictability
JEL(s): F31, G12, G14
Programme Areas: International Macroeconomics, Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=5770

There is widespread evidence of excess return predictability in financial markets. In this paper we examine whether this predictability is related to expectational errors. To consider this issue, we use data on survey expectations of market participants in the stock market, the foreign exchange market, and the bond and money markets in various countries. We find that the predictability of expectational errors coincides with the predictability of excess returns: when a variable predicts expectational errors in a given market, it typically predicts the excess return as well. Understanding expectational errors appears crucial for explaining excess return predictability.