A Predictive System with Heteroscedastic Expected Returns and Economic Constraints

Maxime Bonelli, Daniel Mantilla-Garcia: We propose a variation of a predictive system that incorporates two (additional) economically motivated assumptions about the dynamics of expected returns, namely 1) their positivity, and 2) a time-varying volatility correlated with economic regimes.

Author(s):

Maxime Bonelli

Research Engineer, Koris International

Daniel Mantilla-Garcia

Research Associate, EDHEC-Risk InstituteHead of Research & Development, Koris International

The implications of the modified system are consistent with well established empirical facts of stock returns, in particular, the simpler version of the modified system without predictors can explain the well documented countercyclicality of the dividend-price ratio’s predictive power. In empirical tests we find that the system can produce significantly lower forecast errors than the historical mean out-ofsample as well as some improvement compared to the original system.
Pdf
A Predictive System with Heteroscedastic Expected Returns and Economic Constrain...
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Type: Working paper
Date: le 07/07/2014
Extra information : For more information, please contact EDHEC Research and Development Department [ research@drd.edhec.edu ]
Research Cluster : Finance

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