Modeling the out-of-sample predictive relationship between equity premium, returns on the price of crude oil and economic policy uncertainty using multivariate time-varying dimension models

Nima Nonejad

Energy Economics, 2023, vol. 126, issue C

Abstract: Researchers increasingly rely on the newspaper-based uncertainty (volatility) measures pioneered by Baker et al. (2016) to forecast economic, financial variables and commodity prices out-of-sample. Among them, equity premium and returns on the price of crude oil have received a great deal of attention given their importance. By combining different linear state-space representations of the multivariate dynamic linear model with the discount factor-based model averaging (selection) technique outlined in Raftery et al. (2010), and using monthly data from 1997m1 through 2022m10, we suggest three multivariate time-varying dimension models, and forecast these variables out-of-sample in a contemporaneous fashion. The time-varying dimension feature allows the number of predictors in each regression of the multivariate system to change over time. From a technical viewpoint, the suggested models are intuitive (flexible), and do not require much subjective input from the researcher. They also produce very accurate one-month ahead out-of-sample density (point) forecasts on average. From an empirical viewpoint, our analysis provides new and interesting insights into the out-of-sample predictive relationship between equity premium, returns on the price of crude oil and economic policy uncertainty.

Keywords: Discount factor; Equity premium; Newspaper-based economic policy uncertainty; Returns on the price of crude oil; State-space representation; Time-varying dimension (search for similar items in EconPapers)
JEL-codes: C01 C32 C53 C58 G11 G17 Q47 (search for similar items in EconPapers)
Date: 2023
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Persistent link: https://EconPapers.repec.org/RePEc:eee:eneeco:v:126:y:2023:i:c:s0140988323004620

DOI: 10.1016/j.eneco.2023.106964

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