The Virtue of Complexity in Return Prediction

AuthorS. Malamud, B. T. Kelly, K. Zhou
JournalJournal of Finance
Date4 Jan. 2024
CategoryAcademic Publications
Volume79(1)
Page numbers459–503

Much of the extant literature predicts market returns with “simple” models that use only a few parameters. Contrary to conventional wisdom, we theoretically prove that simple models severely understate return predictability compared to “complex” models in which the number of parameters exceeds the number of observations. We empirically document the virtue of complexity in U.S. equity market return prediction. Our findings establish the rationale for modeling expected returns through machine learning.