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Journal of Financial Econometrics Advance Access originally published online on March 17, 2006
Journal of Financial Econometrics 2006 4(2):238-274; doi:10.1093/jjfinec/nbj008
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© The Author 2006. Published by Oxford University Press. All rights reserved. For permissions, please e-mail: journals.permissions@oxfordjournals.org.

Structural Breaks and Predictive Regression Models of Aggregate U.S. Stock Returns

David E. Rapach
     Saint Louis University

Mark E. Wohar
     University of Nebraska at Omaha

Address correspondence to Mark E. Wohar, Department of Economics, University of Nebraska at Omaha, RH-512K, Omaha, NE 68182-0286, or e-mail: mwohar{at}mail.unomaha.edu.

In this article we examine the structural stability of predictive regression models of U.S. quarterly aggregate real stock returns over the postwar era. We consider predictive regressions models of S&P 500 and CRSP equal-weighted real stock returns based on eight financial variables that display predictive ability in the extant literature. We test for structural stability using the popular Andrews SupF statistic and the Bai subsample procedure in conjunction with the Hansen heteroskedastic fixed-regressor bootstrap. We also test for structural stability using the recently developed methodologies of Elliott and Müller, and Bai and Perron. We find strong evidence of structural breaks in five of eight bivariate predictive regression models of S&P 500 returns and some evidence of structural breaks in the three other models. There is less evidence of structural instability in bivariate predictive regression models of CRSP equal-weighted returns, with four of eight models displaying some evidence of structural breaks. We also obtain evidence of structural instability in a multivariate predictive regression model of S&P 500 returns. When we estimate the predictive regression models over the different regimes defined by structural breaks, we find that the predictive ability of financial variables can vary markedly over time.

KEYWORDS: financial variables, predictive regression model, real stock returns, structural breaks

Received April 14, 2005; revised January 19, 2006; accepted January 30, 2006


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