Market timing and return prediction under model instability

Mohammad Pesaran and Allan Timmermann

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: Despite mounting empirical evidence to the contrary, the literature on predictability of stock returns almost uniformly assumes a time-invariant relationship between state variables and returns. In this paper we propose a two-stage approach for forecasting of financial return series that are subject to breaks. The first stage adopts a reversed ordered Cusum (ROC) procedure to determine in real time when the most recent break has occurred. In the second stage, post-break data is used to estimate the parameters of the forecasting model. We compare this approach to existing alternatives for dealing with parameter instability such as the Bai-Perron method and the time-varying parameter model. An out-of-sample forecasting experiment demonstrates considerable gains in market timing precision from adopting the proposed two-stage forecasting method.

Keywords: predictability of US stock returns; market timing information; structural breaks (search for similar items in EconPapers)
JEL-codes: C22 G10 (search for similar items in EconPapers)
Pages: 23 pages
Date: 2002-03
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (162)

Downloads: (external link)
http://eprints.lse.ac.uk/24932/ Open access version. (application/pdf)

Related works:
Journal Article: Market timing and return prediction under model instability (2002)
Working Paper: Market Timing and Return Prediction under Model Instability (2002)
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:ehl:lserod:24932

Access Statistics for this paper

More papers in LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library LSE Library Portugal Street London, WC2A 2HD, U.K.. Contact information at EDIRC.
Bibliographic data for series maintained by LSERO Manager ().