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Risk Neutral Forecasting

Author

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  • Spyros Skouras

Abstract

A notion of forecast quality is defined that is appropriate when returns forecasts are used in a simple investment decision. The relation between the conditional distribution of returns and optimal point forecasts for a risk neutral investor is characterised and it is shown that the conditional mean is a small subset of optimal forecasts. Taking into account potential model misspecification and the structure of the set of optimal forecasts, methods for developing specifically `risk neutral forecasting' models are proposed. Estimation by Empirical Risk Minimisation is shown to converge to parameters associated with optimal decisions and simulations suggest that performance in small samples is acceptable even in unfavourable circumstances. Usefulness of the proposed methods is illustrated with an empirical application in which they dominate popular alternatives.

Suggested Citation

  • Spyros Skouras, 2001. "Risk Neutral Forecasting," Computing in Economics and Finance 2001 50, Society for Computational Economics.
  • Handle: RePEc:sce:scecf1:50
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    Cited by:

    1. Fong, Wai Mun & Yong, Lawrence H. M., 2005. "Chasing trends: recursive moving average trading rules and internet stocks," Journal of Empirical Finance, Elsevier, vol. 12(1), pages 43-76, January.
    2. Dewachter, Hans & Lyrio, Marco, 2006. "The cost of technical trading rules in the Forex market: A utility-based evaluation," Journal of International Money and Finance, Elsevier, vol. 25(7), pages 1072-1089, November.
    3. Skouras, Spyros, 2003. "An algorithm for computing estimators that optimize step functions," Computational Statistics & Data Analysis, Elsevier, vol. 42(3), pages 349-361, March.

    More about this item

    Keywords

    financial decision-making; empirical risk minimisation;

    JEL classification:

    • C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
    • C44 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Operations Research; Statistical Decision Theory
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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