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Economic uncertainty and time-varying return predictability

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  • Liu, Li

Abstract

We propose a predictive regression for stock returns in which the parameter variation is driven by economic uncertainty. A locally weighted least squares approach is developed to obtain parameter estimates which are used to generate forecasts of returns for the S&P 500 index. Our results indicate that the time-varying parameter model accounting for the role of economic uncertainty (TVP-EU) significantly improves upon the standard ordinary least squares model and the historical average benchmark.

Suggested Citation

  • Liu, Li, 2024. "Economic uncertainty and time-varying return predictability," Finance Research Letters, Elsevier, vol. 68(C).
    • Handle: RePEc:eee:finlet:v:68:y:2024:i:c:s1544612324010559
    DOI: 10.1016/j.frl.2024.106025
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    References listed on IDEAS

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    More about this item

    Keywords

    Economic uncertainty; Equity premium; Weighted least squares; Cross-validation; Out-of-sample forecasting;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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