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Economic Significance of Predictable Variations in Stock Index Returns





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    • Finance Department, Kellogg Graduate School of Management, Northwestern University; Graduate School of Business, Columbia University; Carlson School of Management, University of Minnesota, respectively. We wish to thank Patrick Hess and René Stulz for helpful comments. Part of this research was done while Lawrence Glosten was visiting the Carlson School of Management, University of Minnesota. Ravi Jagannathan wishes to acknowledge financial support from the Banking Research Center at Northwestern University.


Knowledge of the one-month interest rate is useful in forecasting the sign as well as the variance of the excess return on stocks. The services of a portfolio manager who makes use of the forecasting model to shift funds between bills and stocks would be worth an annual management fee of 2% of the value of the assets managed. During 1954:4 to 1986:12, the variance of monthly returns on the managed portfolio was about 60% of the variance of the returns on the value weighted index, whereas the average return was two basis points higher.

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