IDEAS home Printed from https://ideas.repec.org/a/taf/eurjfi/v9y2003i3p273-289.html
   My bibliography  Save this article

Can NN-algorithms and macroeconomic data improve OLS industry returns forecasts?

Author

Listed:
  • Christian Pedersen
  • Stephen Satchell

Abstract

Using an extensive range of macroeconomic indicators and a number of two-stage models mixing OLS and a non-parametric approach known as the nearest neighbour algorithm, the authors analyse the potential for improving forecasts of US industry returns over those built by OLS on industry-specific variables only. Basic performance is measured by the average cross-sectional correlation over time between the 55 forecasted returns and the realized returns across industries. Since investors and asset managers typically want a steady performance over time, the volatility of this cross-sectional correlation is further taken into account in an adaptation of the Sharpe Ratio. Strong evidence is found in favour of certain macroeconomic factors as dominant industry return predictors, and some two-stage models based either purely on OLS or a mix between OLS and the non-linear model can lift both cross-sectional forecasting correlation and Sharpe Ratio. However, viewed overall in relation to the benchmark OLS model, performance is not consistently improved by any particular model.

Suggested Citation

  • Christian Pedersen & Stephen Satchell, 2003. "Can NN-algorithms and macroeconomic data improve OLS industry returns forecasts?," The European Journal of Finance, Taylor & Francis Journals, vol. 9(3), pages 273-289.
    • Handle: RePEc:taf:eurjfi:v:9:y:2003:i:3:p:273-289
    DOI: 10.1080/1351847032000051244
    as

    Download full text from publisher

    File URL: http://www.tandfonline.com/doi/abs/10.1080/1351847032000051244
    Download Restriction: Access to full text is restricted to subscribers.
    File URL: https://libkey.io/10.1080/1351847032000051244?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Manski, Charles F, 1991. "Regression," Journal of Economic Literature, American Economic Association, vol. 29(1), pages 34-50, March.
    2. Douglas T. Breeden & Michael R Gibbons & Robert H. Litzenberger, "undated". "Empirical Tests of the Consumption-Oriented CAPM," Rodney L. White Center for Financial Research Working Papers 07-89, Wharton School Rodney L. White Center for Financial Research.
    3. Breeden, Douglas T & Gibbons, Michael R & Litzenberger, Robert H, 1989. " Empirical Tests of the Consumption-Oriented CAPM," Journal of Finance, American Finance Association, vol. 44(2), pages 231-262, June.
    4. Hall, Anthony D. & Hwang, Soosung & Satchell, Stephen E., 2002. "Using Bayesian variable selection methods to choose style factors in global stock return models," Journal of Banking & Finance, Elsevier, vol. 26(12), pages 2301-2325.
    5. Reilly, Frank K. & Drzycimski, Eugene F., 1974. "Alternative Industry Performance and Risk," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 9(3), pages 423-446, June.
    6. Boudoukh, Jacob & Richardson, Matthew & Whitelaw, Robert F, 1994. "Industry Returns and the Fisher Effect," Journal of Finance, American Finance Association, vol. 49(5), pages 1595-1615, December.
    7. Basu, Parantap & Vinod, Hrishikesh D, 1994. " Mean Reversion in Stock Prices: Implications from a Production Based Asset Pricing Model," Scandinavian Journal of Economics, Wiley Blackwell, vol. 96(1), pages 51-65.
    8. Ferson, Wayne E & Harvey, Campbell R, 1991. "The Variation of Economic Risk Premiums," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 385-415, April.
    9. Jeff Fleming & Chris Kirby & Barbara Ostdiek, 2001. "The Economic Value of Volatility Timing," Journal of Finance, American Finance Association, vol. 56(1), pages 329-352, February.
    10. John H. Cochrane, 1988. "Production Based Asset Pricing," NBER Working Papers 2776, National Bureau of Economic Research, Inc.
    11. Fama, Eugene F. & French, Kenneth R., 1989. "Business conditions and expected returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 25(1), pages 23-49, November.
    12. Pesaran, M Hashem & Timmermann, Allan, 1995. "Predictability of Stock Returns: Robustness and Economic Significance," Journal of Finance, American Finance Association, vol. 50(4), pages 1201-1228, September.
    13. Cochrane, John H, 1991. "Production-Based Asset Pricing and the Link between Stock Returns and Economic Fluctuations," Journal of Finance, American Finance Association, vol. 46(1), pages 209-237, March.
    14. Douglas T. Breeden & Michael R Gibbons & Robert H. Litzenberger, "undated". "Empirical Tests of the Consumption-Oriented CAPM," Rodney L. White Center for Financial Research Working Papers 7-89, Wharton School Rodney L. White Center for Financial Research.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Li, Yuming, 1998. "Expected stock returns, risk premiums and volatilities of economic factors1," Journal of Empirical Finance, Elsevier, vol. 5(2), pages 69-97, June.
    2. João M. Sousa & Ricardo M. Sousa, 2019. "Asset Returns Under Model Uncertainty: Evidence from the Euro Area, the US and the UK," Computational Economics, Springer;Society for Computational Economics, vol. 54(1), pages 139-176, June.
    3. Dou, Winston Wei & Ji, Yan & Wu, Wei, 2021. "Competition, profitability, and discount rates," Journal of Financial Economics, Elsevier, vol. 140(2), pages 582-620.
    4. Vassalou, Maria & Li, Qing & Xing, Yuhang, 2001. "An Investment-Growth Asset Pricing Model," CEPR Discussion Papers 3058, C.E.P.R. Discussion Papers.
    5. Ricardo M. Sousa, 2011. "Asset Returns Under Model Uncertainty: Evidence from the euro area, the U.K. and the U.S," Working Papers w201119, Banco de Portugal, Economics and Research Department.
    6. Robert F. Whitelaw, 1997. "Time-Varying Sharpe Ratios and Market Timing," New York University, Leonard N. Stern School Finance Department Working Paper Seires 98-074, New York University, Leonard N. Stern School of Business-.
    7. Lamont, Owen A., 2001. "Economic tracking portfolios," Journal of Econometrics, Elsevier, vol. 105(1), pages 161-184, November.
    8. Harvey, Campbell R., 2001. "The specification of conditional expectations," Journal of Empirical Finance, Elsevier, vol. 8(5), pages 573-637, December.
    9. Amit Goyal, 2012. "Empirical cross-sectional asset pricing: a survey," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 26(1), pages 3-38, March.
    10. Campbell R. Harvey & Bruno Solnik & Guofu Zhou, 2002. "What Determines Expected International Asset Returns?," Annals of Economics and Finance, Society for AEF, vol. 3(2), pages 249-298, November.
    11. Hardouvelis, Gikas A. & Kim, Dongcheol & Wizman, Thierry A., 1996. "Asset pricing models with and without consumption data: An empirical evaluation," Journal of Empirical Finance, Elsevier, vol. 3(3), pages 267-301, September.
    12. Boons, Martijn & Duarte, Fernando & de Roon, Frans & Szymanowska, Marta, 2020. "Time-varying inflation risk and stock returns," Journal of Financial Economics, Elsevier, vol. 136(2), pages 444-470.
    13. Fernandez, Pablo & Aguirreamalloa, Javier & Liechtenstein, Heinrich, 2009. "The equity premium puzzle: High required equity premium, undervaluation and self fulfilling prophecy," IESE Research Papers D/821, IESE Business School.
    14. Robert F. Dittmar, 2002. "Nonlinear Pricing Kernels, Kurtosis Preference, and Evidence from the Cross Section of Equity Returns," Journal of Finance, American Finance Association, vol. 57(1), pages 369-403, February.
    15. Chrétien, Stéphane, 2012. "Bounds on the autocorrelation of admissible stochastic discount factors," Journal of Banking & Finance, Elsevier, vol. 36(7), pages 1943-1962.
    16. David C. Ling & Andy Naranjo, 1999. "The Integration of Commercial Real Estate Markets and Stock Markets," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 27(3), pages 483-515, September.
    17. John H. Cochrane, 1989. "Using Production Based Asset Pricing to Explain the Behavior of Stock Returns Over the Business Cycle," NBER Working Papers 3212, National Bureau of Economic Research, Inc.
    18. Boons, Martijn, 2016. "State variables, macroeconomic activity, and the cross section of individual stocks," Journal of Financial Economics, Elsevier, vol. 119(3), pages 489-511.
    19. Javid, Attiya Yasmin, 2008. "Time Varying Risk Return Relationship: Evidence from Listed Pakistani Firms," MPRA Paper 37561, University Library of Munich, Germany.
    20. Cooper, Ilan & Priestley, Richard, 2011. "Real investment and risk dynamics," Journal of Financial Economics, Elsevier, vol. 101(1), pages 182-205, July.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:taf:eurjfi:v:9:y:2003:i:3:p:273-289. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Chris Longhurst (email available below). General contact details of provider: http://www.tandfonline.com/REJF20 .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.