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The Economic Value of Predicting Stock Index Returns and Volatility

Author

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  • Wessel Marquering
  • Marno Verbeek

Abstract

In this paper, we analyze the economic value of predicting index returns as well as volatility. On the basis of fairly simple linear models, estimated recursively, we produce genuine out-of-sample forecasts for the return on the S\&P 500 index and its volatility. Using monthly data from 1954 to 1998, we test the statistical significance of return and volatility predictability and examine the economic value of a number of alternative trading strategies. We find strong evidence for market timing in both returns and volatility. Joint tests indicate no dependence between return and volatility timing, while it appears easier to forecast returns when volatility is high. For a mean-variance investor, this predictability is economically profitable, even if short sales are not allowed and transaction costs are quite large.

Suggested Citation

  • Wessel Marquering & Marno Verbeek, 2000. "The Economic Value of Predicting Stock Index Returns and Volatility," Working Papers of Department of Economics, Leuven ces0020, KU Leuven, Faculty of Economics and Business (FEB), Department of Economics, Leuven.
  • Handle: RePEc:ete:ceswps:ces0020
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    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
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G3 - Financial Economics - - Corporate Finance and Governance
    • M - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics

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