Multiperiod forecasting in stock markets: a paradox solved

One of the most striking results on asset pricing in the last 20 years is the better forecastability of long-horizon returns over one-step return forecasts. This could seem a paradox, given that the further our forecast horizon the greater the uncertainty we are bound to face. This point can be found in Campbell and Shiller among others. In this paper, we offer an alternative explanation to this “forecast paradox” that is in agreement with Kim et al., who found that the negative serial correlation in long-horizon returns depends very much on the sample choice. Our explanation is based on the existence of simultaneous shifts in the time series of the equilibrium stock price and dividends. This explanation relies on the concept of co-breaking. We put forward a stochastic present value model, in which we are able to show how shifts in the process for dividends lead to shifts in the equilibrium stock price.