An examination of the economic significance of stock return predictability in UK stock returns

We explore the out-of-sample performance of domestic UK asset allocation strategies that use forecasts of expected returns from a linear predictive regression and those that are implied by asset pricing models such as the capital asset pricing model (CAPM) or arbitrage pricing theory (APT). Our findings suggest that using forecasts of expected returns from the predictive regression generate significant benefits in out-of-sample performance. We find the performance of the strategies using expected return forecasts implied by the CAPM or APT is lower than the predictive regression strategy. However, with binding investment constraints, the performance of the APT matches that of the predictive regression.