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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):
Research Engineer, Koris International
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.
| Type: | Working paper |
|---|---|
| Date: | le 07/07/2014 |
| Research Cluster : | Finance |
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