Stock return predictability: Empirical testing of various financial variables´predictive ability on stock returns

Marte Møller Garthus & Louise Amb Dyrdal

Student thesis: Master thesis

Abstract

The existing literature on stock return predictability includes several different studies that over the years have gathered a significant amount of information regarding a variable’s ability to predict future stock return. A variety of parameters and variables have been tested and the conclusion of different scholars indicates that several of these contain predictive power. In this master thesis we investigate whether dividend yield, price-earnings, cay, interest rate, momentum, and Sharpe ratio can predict future stock returns over a short horizon. We have included the most recent data available and attempted to test for the effect of the financial crisis of 2008. To examine whether there exists similar patterns across different international markets we have included the U.S., the Norwegian, and the Swedish market in our analysis. Our results indicate a presence of predictability in our explanatory variables, and especially cay, interest rate, and Sharpe ratio are significantly strong predictors. Predictability in interest rate and Sharpe ratio is robust over several markets since they show strong prediction in the Scandinavian data as well. According to our findings, the occurrences during and after the recent financial crisis have affected the predictive ability of our explanatory variables. By excluding the observations after 2007 from our sample, several of the variables become significant predictors. Overall, we find various cases of predictability in our variables depending on the method applied, sample period, and market.

EducationsMSc in Finance and Strategic Management, (Graduate Programme) Final Thesis
LanguageEnglish
Publication date2014
Number of pages163