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Modelling and forecasting stock returns: exploiting the futures market, regime shifts and international spillovers

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Author Info
Giorgio Valente (University of Warwick, Coventry, UK)
Lucio Sarno (University of Warwick, Coventry, UK and Centre for Economic Policy Research (CEPR), London, UK)

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Abstract

This paper proposes a vector equilibrium correction model of stock returns that exploits the information in the futures market, while allowing for both regime-switching behaviour and international spillovers across stock market indices. Using data for three major stock market indices since 1989, we find that: (i) in sample, our model outperforms several alternative models on the basis of standard statistical criteria; (ii) in out-of-sample forecasting, our model does not produce significant gains in terms of point forecasts relative to more parsimonious alternative specifications, but it does so both in terms of market timing ability and in density forecasting performance. The economic value of the density forecasts is illustrated with an application to a simple risk management exercise. Copyright © 2005 John Wiley & Sons, Ltd.

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File URL: http://hdl.handle.net/10.1002/jae.787
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Publisher Info
Article provided by John Wiley & Sons, Ltd. in its journal Journal of Applied Econometrics.

Volume (Year): 20 (2005)
Issue (Month): 3 ()
Pages: 345-376
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Handle: RePEc:jae:japmet:v:20:y:2005:i:3:p:345-376

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References listed on IDEAS
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  4. Perez-Quiros, Gabriel & Timmermann, Allan, 2001. "Business cycle asymmetries in stock returns: Evidence from higher order moments and conditional densities," Journal of Econometrics, Elsevier, vol. 103(1-2), pages 259-306, July. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Massimo Guidolin & Stuart Hyde, 2007. "What tames the Celtic tiger? portfolio implications from a multivariate Markov switching model," Working Papers 2006-029, Federal Reserve Bank of St. Louis. [Downloadable!]
    Other versions:
  2. Clarida, Richard & Sarno, Lucio & Taylor, Mark P & Valente, Giorgio, 2005. "The Role of Asymmetries and Regime Shifts in the Term Structure of Interest Rates," CEPR Discussion Papers 4835, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
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