Forecasting stock market returns: the sum of the parts is more than the whole

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250 Citations (Scopus)


We propose forecasting separately the three components of stock market returns the dividend-price ratio, earnings growth, and price-earnings ratio growth the sum-of-the-parts (SOP) method. Our method exploits the different time series persistence of the components and obtains out-of-sample R-squares (compared with the historical mean) of more than 1.3% with monthly data and 13.4% with yearly data. This compares with typically negative R-squares obtained in a similar experiment with predictive regressions. The performance of the SOP method comes mainly from the dividend-price ratio and earnings growth components, and the robustness of the method is due to its low estimation error. An investor who timed the market using our method would have had a Sharpe ratio gain of 0.3. (C) 2011 Elsevier B.V. All rights reserved.
Original languageEnglish
Pages (from-to)514-537
JournalJournal of Financial Economics
Issue number3
Publication statusPublished - 1 Jun 2011


  • Predictability
  • Stock returns
  • Equity premium


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