Instability of return prediction models

This study examines evidence of instability in models of ex post predictable components in stock returns related to structural breaks in the coefficients of state variables such as the lagged dividend yield, short interest rate, term spread and default premium. We estimate linear models of excess returns for a set of international equity indices and test for stability of the estimated regression parameters. There is evidence of instability for the vast majority of countries. Breaks do not generally appear to be uniform in time: different countries experience breaks at different times. For the majority of international indices, the predictable component in stock returns appears to have diminished following the most recent break. We assess the adequacy of the break tests and model selection procedures in a set of Monte Carlo experiments.