Economic Significance of Predictable Variations in Stock Index Returns

Abstract

Knowledge of the one‐month interest rate is useful in forecasting the sign as well as the variance of the excess return on stocks. The services of a portfolio manager who makes use of the forecasting model to shift funds between bills and stocks would be worth an annual management fee of 2% of the value of the assets managed. During 1954:4 to 1986:12, the variance of monthly returns on the managed portfolio was about 60% of the variance of the returns on the value weighted index, whereas the average return was two basis points higher.

Modeling the Conditional Covariance Between Stock and Bond Returns: A Multivariate GARCH Approach

“…Many studies consider the conditional volatility in stock markets and bond markets separately (e.g. Breen, Glosten andEngle, Lilien andRoberts, 1987).…”

“…Only since the last decade financial economists have begun to model these temporal dependencies. For example, Breen, Glosten and Jagannathan (1989) show that there is a negative relation between short term interest rates and future stock index returns, and Schwert (1989) documents that U.S. stock and bond returns and volatilities move together. A recent study by Fleming, Kirby and Ostdiek (1998) examines volatility interaction of stock, bond and money markets using a stochastic volatility model.…”

The Intertemporal Relation between Expected Return and Risk on Currency

“…Several studies find that the intertemporal relation between risk and return is negative (e.g., Campbell (1987), Breen, Glosten, and Jagannathan (1989), Turner, Startz, and Nelson (1989), Nelson (1991, Glosten, Jagannathan, and Runkle (1993), Harvey (2001), and Brandt and Kang (2004)). Some studies do provide evidence supporting a positive and significant relation between expected return and 13 risk on stock market portfolios (e.g., Bollerslev, Engle, and Wooldridge (1988), Scruggs (1998), Ghysels, Santa-Clara, and Valkanov (2005), Bali and Peng (2006), Guo and Whitelaw (2006), Lundblad (2007), and Bali (2008)).…”

Forecasting Returns with Fundamentals-Removed Investor Sentiment

“…While the intercept in this specification can be interpreted as selection ability, Goetzman, Ingersoll, and Ivković [33] note that the selection ability coefficients and market timing ability coefficients are typically of the opposite sign. The Cumby and Modest [30] test (CM), but following Breen, Glosten, and Jagannathan [34] is also performed. They do not assume a CAPM structure and directly test whether the expected realized return is different when an up market is predicted compared to when a down market is predicted.…”

“…Again, the market timing ability coefficient is positive and significant at 1%, providing positive evidence of timing ability. Breen, Glosten, and Jagannathan [34] also note that a negative intercept is equivalent to the expected return of the timing portfolio being higher than the return on the market (buy-and-hold strategy). Panel B shows a negative intercept that is significant at 10%.…”