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Cross-Correlations and Predictability of Stock Returns

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  • Olson, Dennis
  • Mossman, C

Abstract

Studies have shown that small stock returns can be partially predicted by the past returns of large stocks (cross-correlations), while a larger body of literature has shown that macroeconomic variables can predict future stock returns. This paper assesses the marginal contribution of cross-correlations after controlling for predictability inherent in lagged macroeconomic variables. Macroeconomic forecasting models generate trading rule profits of up to 0.431% per month, while the inclusion of cross-correlations increases returns to 0.516% per month. Such results suggest that cross-correlations may serve as a proxy for omitted macroeconomic variables in studies of stock market predictability. Macroeconomic variables are more important than cross-correlations in forecasting small stock returns and encompassing tests suggest that the small marginal contribution of cross-correlations is not statistically significant. Copyright © 2001 by John Wiley & Sons, Ltd.

Suggested Citation

  • Olson, Dennis & Mossman, C, 2001. "Cross-Correlations and Predictability of Stock Returns," Journal of Forecasting, John Wiley & Sons, Ltd., vol. 20(2), pages 145-160, March.
    • Handle: RePEc:jof:jforec:v:20:y:2001:i:2:p:145-60
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    Cited by:

    1. Manuel Ammann & Christian Zenkner, 2003. "Tactical Asset Allocation mit Genetischen Algorithmen," Swiss Journal of Economics and Statistics (SJES), Swiss Society of Economics and Statistics (SSES), vol. 139(I), pages 1-40, March.
    2. Bensafta, Kamel Malik & Semedo, Gervasio, 2009. "De la transmission de la volatilité à la contagion entre marchés boursiers : l’éclairage d’un modèle VAR non linéaire avec bris structurels en variance," L'Actualité Economique, Société Canadienne de Science Economique, vol. 85(1), pages 13-76, mars.
    3. Olson, Dennis & Zoubi, Taisier A., 2008. "Using accounting ratios to distinguish between Islamic and conventional banks in the GCC region," The International Journal of Accounting, Elsevier, vol. 43(1), pages 45-65, March.

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