The Economic Value of Predicting Stock Index Returns and Volatility

Wessel Marquering and Marno Verbeek

ERIM Report Series Research in Management from Erasmus Research Institute of Management (ERIM), ERIM is the joint research institute of the Rotterdam School of Management, Erasmus University and the Erasmus School of Economics (ESE) at Erasmus University Rotterdam

Abstract: In this paper, we analyze the economic value of predicting stock index returns as well as volatility. On the basis of simple linear models, estimated recursively, we produce genuine out-of-sample forecasts for the return on the S&P 500 index and its volatility. Using monthly data from 1954 to 2001, we test the statistical significance of return and volatility predictability and examine the economic value of a number of alternative trading strategies. While we find strong evidence for market timing in both returns and volatility, the success of market timing and volatility timing varies considerably over the sample period. Further, it appears easier to forecast returns at times when volatility is high. For a mean-variance investor, this predictability is economically profitable, even if short sales are not allowed and transaction costs are quite large. The economic value of trading strategies that employ market timing in returns and volatility exceeds that of strategies that only employ timing in returns.

Keywords: investments; market timing; performance evaluation; predictability of stock returns and volatility (search for similar items in EconPapers)
JEL-codes: G11 G14 G24 G3 M (search for similar items in EconPapers)
Date: 2001-12-10
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Citations: View citations in EconPapers (1)

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Related works:
Journal Article: The Economic Value of Predicting Stock Index Returns and Volatility (2004)
Working Paper: The Economic Value of Predicting Stock Index Returns and Volatility (2000)
Working Paper: The Economic Value of Predicting Stock Index Returns and Volatility (2000)
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