Modeling stock index returns by means of partial least‐squares methods: An out‐of‐sample analysis for three stock markets |
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Authors: | Cetin‐Behzet Cengiz Helmut Herwartz |
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Institution: | 1. Chair of Decision Theory and Financial Services, RWTH‐Aachen University, Templergraben 56, Aachen, Germany;2. Institute for Statistics and Econometrics, Christian‐Albrechts‐University of Kiel, Olshausenstr. 40‐60 Kiel, Germany |
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Abstract: | We analyze the underlying economic forces of the stock markets in Germany, the U.K. and the U.S. Identifying a number of variables evincing return predictability, we follow a partial least‐squares (PLS) approach to combine these observables into a few latent factors. Conditional on European markets, our findings indicate (i) superior prediction performance of PLS‐based schemes in comparison with both, a random walk and a first‐order autoregressive benchmark model, (ii) consistent profitable trading on the German and British market, (iii) profitable linear forecast combinations, (iv) the U.S. stock market is diagnosed as informationally efficient. Copyright © 2010 John Wiley & Sons, Ltd. |
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Keywords: | return predictability partial least‐squares out‐of‐sample prediction dynamic factor model trading rules |
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