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Regime shifts and stock return predictability


Hammerschmid, Regina; Lohre, Harald (2018). Regime shifts and stock return predictability. International Review of Economics and Finance, 56:138-160.

Abstract

Identifying economic regimes is useful in a world of time-varying risk premia. We apply regime switching models to common factors proxying for the macroeconomic regime and show that the ensuing regime factor is relevant in forecasting the equity risk premium. Moreover, the relevance of this regime factor is preserved in the presence of fundamental variables and technical indicators which are known to predict equity risk premia. Based on multiple predictive regressions and pooled forecasts, the macroeconomic regime factor is deemed complementary relative to the fundamental and technical information sets. Finally, these forecasts exhibit significant out-of-sample predictability that ultimately translates into considerable utility gains in a mean-variance portfolio strategy.

Abstract

Identifying economic regimes is useful in a world of time-varying risk premia. We apply regime switching models to common factors proxying for the macroeconomic regime and show that the ensuing regime factor is relevant in forecasting the equity risk premium. Moreover, the relevance of this regime factor is preserved in the presence of fundamental variables and technical indicators which are known to predict equity risk premia. Based on multiple predictive regressions and pooled forecasts, the macroeconomic regime factor is deemed complementary relative to the fundamental and technical information sets. Finally, these forecasts exhibit significant out-of-sample predictability that ultimately translates into considerable utility gains in a mean-variance portfolio strategy.

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Additional indexing

Item Type:Journal Article, refereed, original work
Communities & Collections:03 Faculty of Economics > Department of Banking and Finance
Dewey Decimal Classification:330 Economics
Language:English
Date:July 2018
Deposited On:27 Feb 2019 16:43
Last Modified:27 Feb 2019 16:44
Publisher:Elsevier
ISSN:1059-0560
OA Status:Closed
Publisher DOI:https://doi.org/10.1016/j.iref.2017.10.021
Other Identification Number:merlin-id:15376

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