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Forecasting the Bond-Equity Yield Ratio Using Regime Switching and Cointegration Models: An international Comparison

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Listed:
  • Mikael Petitjean
  • Pierre Giot

Abstract

The bond-equity yield ratio is defined as the ratio of the coupon yield on long government bonds to the dividend yield on equity. Commonly named in the UK as the gilt-equity yield ratio (GEYR), it has been argued to capture the relative value of bonds and equities through the di fferential in their income yield. While Brooks and Persand (2001) have been the first to endogenise the threshold at which the ratio switches from being high or low and vice versa, they just use one single trading rule based on the one-step ahead forecasted value of the ratio, for three di fferent countries. We add another trading rule based on the one-step ahead forecasted probability of being in the high (or low) regime and extend the sample to seven countries, including Japan, the Netherlands, Belgium and France. We also use another methodological approach based on cointegration analysis since stock index prices, dividends and interest rates may be found to have a stationary long-term relationship. We finally conclude by comparing the forecasting ability of these two approaches with classical models such as Random Walk with drift, SETAR, MA(1)-GARCH and AR(p)

Suggested Citation

  • Mikael Petitjean & Pierre Giot, 2004. "Forecasting the Bond-Equity Yield Ratio Using Regime Switching and Cointegration Models: An international Comparison," Computing in Economics and Finance 2004 6, Society for Computational Economics.
  • Handle: RePEc:sce:scecf4:6
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    More about this item

    Keywords

    Equity Yield; GEYR; Markov Switching; Regime Model; Forecasting; Cointegration;

    JEL classification:

    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • F37 - International Economics - - International Finance - - - International Finance Forecasting and Simulation: Models and Applications

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