Arbeitspapier
Predictability of Bull and Bear Markets: A New Look at Forecasting Stock Market Regimes (and Returns) in the US
The empirical literature of stock market predictability mainly suffers from model uncertainty and parameter instability. To meet this challenge, we propose a novel approach that combines the documented merits of diffusion indices, regime-switching models, and forecast combination to predict the dynamics in the S&P 500. First, we aggregate the weekly information of 115 popular macroeconomic and financial variables through an interaction of principal component analysis and shrinkage methods. Second, we estimate one-step Markov-switching models with time-varying transition probabilities using the diffusion indices as predictors. Third, we pool the forecasts in clusters to hedge against model risk and to evaluate the usefulness of different specifications. Our results show that we can adequately predict regime dynamics. Our forecasts provide a statistical improvement over several benchmarks and generate economic value by boosting returns, improving the certainty equivalent return, and reducing tail risk. Using the same approach for return forecasts, however, does not lead to a consistent outperformance of the historical average.
- Language
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Englisch
- Bibliographic citation
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Series: CESifo Working Paper ; No. 8828
- Classification
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Wirtschaft
Forecasting Models; Simulation Methods
Portfolio Choice; Investment Decisions
Financial Forecasting and Simulation
- Subject
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forecast combination
Markov-Switching Models
shrinkage methods
stock market regimes
time-varying transition probabilities
- Event
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Geistige Schöpfung
- (who)
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Haase, Felix
Neuenkirch, Matthias
- Event
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Veröffentlichung
- (who)
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Center for Economic Studies and Ifo Institute (CESifo)
- (where)
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Munich
- (when)
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2021
- Handle
- Last update
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10.03.2025, 11:43 AM CET
Data provider
ZBW - Deutsche Zentralbibliothek für Wirtschaftswissenschaften - Leibniz-Informationszentrum Wirtschaft. If you have any questions about the object, please contact the data provider.
Object type
- Arbeitspapier
Associated
- Haase, Felix
- Neuenkirch, Matthias
- Center for Economic Studies and Ifo Institute (CESifo)
Time of origin
- 2021
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Central banks' predictability: An assessment by financial market participants
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Bank of Canada communication and the predictability of Canadian monetary policy
Are public preferences reflected in monetary policy reaction functions?
Central bank transparency and financial market expectations: The case of emerging markets
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Establishing a hawkish reputation: Interest rate setting by newly appointed central bank governors
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Federal reserve communications and newswire coverage
Predictability of Bull and Bear Markets: A New Look at Forecasting Stock Market Regimes (and Returns) in the US
Central banks' predictability: An assessment by financial market participants
Central banks' predictability: An assessment by financial market participants
Bank of Canada communication and the predictability of Canadian monetary policy
Are public preferences reflected in monetary policy reaction functions?
Central bank transparency and financial market expectations: The case of emerging markets
Managing financial market expectations: The role of central bank transparency and central bank communication
Predicting Bank of England's asset purchase decisions with MPC voting records
Establishing a hawkish reputation: Interest rate setting by newly appointed central bank governors
An unconventional approach to evaluate the Bank of England's asset purchase program
Monetary policy transmission in vector autoregressions: A new approach using central bank communication