Model uncertainty and asset return predictability: an application of Bayesian model averaging

Rumi Masih, A. Mansur M. Masih and Kilian Mie
Authors registered in the RePEc Author Service: Abul Mansur Mohammed Masih

Applied Economics, 2010, vol. 42, issue 15, 1963-1972

Abstract: We investigate model uncertainty associated with predictive regressions employed in asset return forecasting research. We use simple combination and Bayesian model averaging (BMA) techniques to compare the performance of these forecasting approaches in short-vs. long-run horizons of S&P500 monthly excess returns. Simple averaging involves an equally-weighted averaging of the forecasts from alternative combinations of factors used in the predictive regressions, whereas BMA involves computing the predictive probability that each model is the true model and uses these predictive probabilities as weights in combing the forecasts from different models. From a given set of multiple factors, we evaluate all possible pricing models to the extent, which they describe the data as dictated by the posterior model probabilities. We find that, while simple averaging compares quite favorably to forecasts derived from a random walk model with drift (using a 10-year out-of-sample iterative period), BMA outperforms simple averaging in longer compared to shorter forecast horizons. Moreover, we find further evidence of the latter when the predictive Bayesian model includes shorter, rather than longer lags of the predictive factors. An interesting outcome of this study tends to illustrate the power of BMA in suppressing model uncertainty through model as well as parameter shrinkage, especially when applied to longer predictive horizons.

Date: 2010
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

Downloads: (external link)
http://www.tandfonline.com/doi/abs/10.1080/00036840701736214 (text/html)
Access to full text is restricted to subscribers.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:taf:applec:v:42:y:2010:i:15:p:1963-1972

Ordering information: This journal article can be ordered from
http://www.tandfonline.com/pricing/journal/RAEC20

DOI: 10.1080/00036840701736214

Access Statistics for this article

Applied Economics is currently edited by Anita Phillips

More articles in Applied Economics from Taylor & Francis Journals
Bibliographic data for series maintained by Chris Longhurst ().