Pesaran, M. Hashem and Timmermann, Allan (2002) Market timing and return prediction under model instability. Discussion paper, 412. Financial Markets Group, London School of Economics and Political Science, London, UK.
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Abstract
Despite mounting empirical evidence to the contrary, the literature on predictability of stock returns almost uniformly assumes a time-invariant relationship between state variables and returns. In this paper we propose a two-stage approach for forecasting of financial return series that are subject to breaks. The first stage adopts a reversed ordered Cusum (ROC) procedure to determine in real time when the most recent break has occurred. In the second stage, post-break data is used to estimate the parameters of the forecasting model. We compare this approach to existing alternatives for dealing with parameter instability such as the Bai-Perron method and the time-varying parameter model. An out-of-sample forecasting experiment demonstrates considerable gains in market timing precision from adopting the proposed two-stage forecasting method.
| Item Type: | Monograph (Discussion Paper) |
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| Official URL: | http://fmg.lse.ac.uk |
| Additional Information: | © 2002 The Authors |
| Subjects: | H Social Sciences > HF Commerce H Social Sciences > HG Finance H Social Sciences > HB Economic Theory |
| Sets: | Research centres and groups > Financial Markets Group (FMG) Collections > Economists Online Collections > LSE Financial Markets Group (FMG) Working Papers |
| Date Deposited: | 20 Aug 2009 09:59 |
| Last Modified: | 27 Feb 2014 15:36 |
| URI: | http://eprints.lse.ac.uk/id/eprint/24932 |
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