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Regime shifts and stock return predictability

Regina Hammerschmid and Harald Lohre

International Review of Economics & Finance, 2018, vol. 56, issue C, 138-160

Abstract: Identifying economic regimes is useful in a world of time-varying risk premia. We apply regime switching models to common factors proxying for the macroeconomic regime and show that the ensuing regime factor is relevant in forecasting the equity risk premium. Moreover, the relevance of this regime factor is preserved in the presence of fundamental variables and technical indicators which are known to predict equity risk premia. Based on multiple predictive regressions and pooled forecasts, the macroeconomic regime factor is deemed complementary relative to the fundamental and technical information sets. Finally, these forecasts exhibit significant out-of-sample predictability that ultimately translates into considerable utility gains in a mean-variance portfolio strategy.

Keywords: Return predictability; Regime switching; Predictive regressions (search for similar items in EconPapers)
Date: 2018
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Handle: RePEc:eee:reveco:v:56:y:2018:i:c:p:138-160