PREDICTABILITY OF STOCK RETURNS AND REAL OUTPUT

This paper investigates the predictability of stock returns using diff erent components of output. Instead of using aggregate output as the s tate variable, we decompose aggregate output into its permanent and tr ansitory components. Our empirical results indicate that the permanent component of output provides virtually all of the predictability attr ibuted to the aggregate output variable. The transitory component of o utput is shown to contain no useful information regarding the predicta bility of stock returns. We argue that these results are consistent wi th general equilibrium pricing models and efficient markets.