Forecast ranked tailored equity portfolios

Daniel Buncic and Cord Stern

Journal of International Financial Markets, Institutions and Money, 2019, vol. 63, issue C

Abstract: We use a dynamic model averaging (DMA) approach to construct forecasts of individual equity returns for a large cross-section of stocks contained in the SP500, FTSE100, DAX30, CAC40 and SPX30 headline indices, taking value, momentum, and quality factors as predictor variables. Fixing the set of ‘forgetting factors’ in the DMA prediction framework, we show that highly significant return forecasts relative to the historic average benchmark are obtained for 173 (281) individual equities at the 1% (5%) level, from a total of 895 stocks. These statistical forecast improvements also translate into considerable economic gains, producing out-of-sample R2 values above 5% (10%) for 283 (166) of the 895 individual stocks. Equally weighted long only portfolios constructed from a ranking of the best 25% forecasts in each headline index can generate sizable returns in excess of a passive investment strategy in that index itself, even when transaction costs and risk taking are accounted for.

Keywords: Active factor models; Model averaging and selection; Computational finance; Quantitative equity investing; Stock selection strategies; Return-based factor models (search for similar items in EconPapers)
JEL-codes: C11 C52 F37 G11 G15 G17 (search for similar items in EconPapers)
Date: 2019
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Persistent link: https://EconPapers.repec.org/RePEc:eee:intfin:v:63:y:2019:i:c:s1042443119301325

DOI: 10.1016/j.intfin.2019.101138

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