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Economic Value of Stock and Interest Rate Predictability in the UK

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  • Stephen Hall

    ()

  • Kavita Sirichand

    ()

Abstract

In this paper, we evaluate the forecast performance of a range of atheoretic and theory informed models of bond and stock returns. The decision making environment is fully described for an investor who would like to optimally allocate his portfolio between bonds and stocks, over an investment horizon of up to two years. We use a weekly dataset on UK Treasury Bill rates and the FTSE All-Share Index over the period 1997 to 2007, to examine the impact parameter uncertainty and predictability in returns have on how the investor optimally allocates his portfolio. The methods by which the forecasts should be computed and used in this context are described. Both statistical and decision based criteria are used to evaluate the out-of-sample forecasting performance of the models. Our results suggest that in the context of investment decision making under an economic value criterion, the investor gains from not only assuming predictability but by modelling the bond and stock returns together.

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Bibliographic Info

Paper provided by Department of Economics, University of Leicester in its series Discussion Papers in Economics with number 10/13.

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Date of creation: Apr 2010
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Handle: RePEc:lec:leecon:10/13

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Postal: Department of Economics University of Leicester, University Road. Leicester. LE1 7RH. UK
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Related research

Keywords: Density Forecasting; Decision-based Forecast Evaluation; Interest Rate and Stock Return Models; Predictability and Parameter Uncertainty;

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  1. Sarno, Lucio & Thornton, Daniel L & Valente, Giorgio, 2005. "The Empirical Failure of the Expectations Hypothesis of the Term Structure of Bond Yields," CEPR Discussion Papers 5259, C.E.P.R. Discussion Papers.
  2. Della Corte, Pasquale & Sarno, Lucio & Thornton, Daniel L., 2008. "The expectation hypothesis of the term structure of very short-term rates: Statistical tests and economic value," Journal of Financial Economics, Elsevier, vol. 89(1), pages 158-174, July.
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