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The Economic Value of Predicting Stock Index Returns and Volatility

Published online by Cambridge University Press:  06 April 2009

Wessel Marquering  and
Marno Verbeek
Wessel Marquering
Affiliation:
w.marquering@fbk.eur.nl, Department of Financial Management
Marno Verbeek
Affiliation:
mverbeek@fbk.eur.nl, Department of Financial Management and Econometric Institute, Erasmus University Rotterdam, F4-26, PO Box 1738, 3000 DR Rotterdam, The Netherlands.
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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 out-of-sample forecasts for the return on the S&P 500 index and its volatility. Using monthly data, we examine the economic value of a number of alternative trading strategies over the period 1970–2001. 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. Most of the profitability of the dynamic strategies, however, is located in the first half of our sample period.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 39 , Issue 2 , June 2004 , pp. 407 - 429
Copyright
Copyright © School of Business Administration, University of Washington 2004

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