No Predictable Components in G7 Stock Returns

We search for time-varying predictable components in monthly excess stock index returns over the risk free rates in the G7 countries. The predictable components provide an estimate of the expected excess returns. Our unobserved components model improves on Conrad and Kaul (1988) by taking into account fat tails widely documented in returns data. Statistical hypotheses tests fail to reveal any significant time-varying predictable components in excess returns for any of the countries, except Canada. Our results are in sharp contrast to Conrad and Kaul (1988), who do isolate time-varying expected returns in weekly sizeweighted portfolio returns using the same methodology but in a Gaussian setting.