Asset Returns Under Model Uncertainty: Evidence from the Euro Area, the US and the UK

João M. Sousa () and Ricardo Sousa
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João M. Sousa: European Central Bank

Computational Economics, 2019, vol. 54, issue 1, No 8, 139-176

Abstract: Abstract We analyze predictability of risk premium in the context of model uncertainty. Using data for the euro area, the US and the UK, we show that there is a large amount of model uncertainty and one can improve the forecasts of stock returns with a Bayesian Model Averaging (BMA) approach. The empirical evidence for the euro area suggests that several macroeconomic, financial and macro-financial variables are consistently among the most prominent determinants of risk premium. As for the US, only a few number of predictors play an important role. In the case of the UK, future stock returns are better forecasted by financial variables. These results are corroborated for both the M-open and the M-closed perspectives, different model priors and in the context of “in-sample” and “out-of-sample” forecasting. Finally, we highlight that the predictive ability of the BMA framework is stronger at longer periods, and clearly outperforms the constant expected returns and the autoregressive benchmark models.

Keywords: Stock returns; Model uncertainty; Bayesian Model Averaging (search for similar items in EconPapers)
JEL-codes: E21 E44 G11 (search for similar items in EconPapers)
Date: 2019
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Citations: View citations in EconPapers (3)

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Related works:
Working Paper: Asset returns under model uncertainty: evidence from the euro area, the U.S. and the U.K (2013)
Working Paper: Asset Returns Under Model Uncertainty: Evidence from the euro area, the U.K. and the U.S (2011)
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DOI: 10.1007/s10614-017-9696-2

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