Asset Returns Under Model Uncertainty: Evidence from the Euro Area, the US and the UK

Abstract

Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. The refereeing process of this paper has been coordinated by a team composed of Gerhard Rünstler, Kalin Nikolov and Bernd Schwaab (all ECB). Terms of use: Documents in EconStor mayThe paper is released in order to make the research of MaRs generally available, in preliminary form, to encourage comments and suggestions prior to final publication. The views expressed in the paper are the ones of the author(s) and do not necessarily reflect those of the ECB or of the ESCB. The goal of this paper is to analyze predictability of future asset returns in the context of model uncertainty. Using data for the euro area, the US and the U.K., we show that one can improve the forecasts of stock returns using a model averaging approach, and there is a large amount of model uncertainty. The empirical evidence for the euro area suggests that several macroeconomic, …nancial and macro-…nancial variables are consistently among the most prominent determinants of the risk premium. As for the US, only a few predictors play an important role. In the case of the UK, future stock returns are better forecast by …nancial variables. João SousaKeywords: Stock returns, model uncertainty, Bayesian Model Averaging. JEL classi…cation: E21, G11, E44. Non-Technical SummaryThe Great Recession drew the attention of many academics, central banks and policy makers to the destabilizing power of …nancial markets. Financial instability became a prominent concern, thus, leading to an intense research e¤ort to better understand the behaviour of asset markets and the roots and causes of …nancial imbalances.From a policy perspective, this line of investigation should help developing tools that can provide early warning indicators and which will contribute to the design of macroprudential policies aimed at preventing that such imbalances arise and mitigating their e¤ects. Those indicators are important as asset ‡uctuations can degenerate in bubbles or price misalignments that may ultimately lead to …nancial disruptions. This stream of research is also valuable for monetary policy purposes, given that it helps assessing the uncertainty faced by monetary authorities in relation to …nancial markets. As such, it can provide evidence regarding where macroprudential policy should act (an important example being the …ndings that link excessive credit growth to asset price booms).Our work analyses stock market returns. One di¢ culty in studying their behaviour is that there is no agreement on how they should ...

Predicting asset returns in the BRICS: The role of macroeconomic and fundamental predictors

“…o Change in real bilateral exchange rate vis-a-vis the US Dollar (Sousa and Sousa, 2013); and o Risk-free rate / Money market rate, i.e. the interest rate on a low risk short-term security (Goyal and Welch, 2008).…”

Weighted-Average Least Squares (WALS): Confidence and Prediction Intervals

“…Adding auxiliary regressors tends to reduce omitted variable bias in estimating the focus parameters, but tends to increase sampling variability. Examples include studies concerning the determinants of economic growth (Sala-i-Martin et al 2004;Magnus et al 2010), risk premia (Sousa and Sousa 2019), product and labor market reforms (Duval et al 2021), the impact of legalized abortion on crime (Donohue and Levitt 2001), and the relationship between body mass and income (Dardanoni et al 2011).…”