Modeling the Cross Section of Stock Returns: A Model Pooling Approach

54 Pages Posted: 15 Mar 2010 Last revised: 6 May 2012

Michael S. O'Doherty

University of Missouri at Columbia - Department of Finance

N. Eugene Savin

University of Iowa - Henry B. Tippie College of Business - Department of Economics

Ashish Tiwari

University of Iowa

Date Written: August 18, 2011

Abstract

Model selection, i.e., the choice of an asset pricing model to the exclusion of competing models, is an inherently misguided strategy when the true model is unavailable to the researcher. This paper illustrates the advantages of a model pooling approach in characterizing the cross section of stock returns. The optimal pool combines models using the log predictive score criterion, a measure of the out-of-sample performance of each model, and consistently outperforms the best individual model. The bene fits to model pooling are most pronounced during periods of economic stress and it is a valuable tool for asset allocation decisions.

Keywords: Asset pricing, Model pooling, Model combination, Forecasting, Predictive distributions, Log predictive score

JEL Classification: G12, C52, C53

Suggested Citation

O'Doherty, Michael S. and Savin, N. Eugene and Tiwari, Ashish, Modeling the Cross Section of Stock Returns: A Model Pooling Approach (August 18, 2011). Journal of Financial and Quantitative Analysis (JFQA), Forthcoming. Available at SSRN: https://ssrn.com/abstract=1570772 or http://dx.doi.org/10.2139/ssrn.1570772

Michael S. O'Doherty

University of Missouri at Columbia - Department of Finance ( email )

Robert J. Trulaske, Sr. College of Business
403 Cornell Hall
Columbia, MO 65211
United States

Nathan Eugene Savin

University of Iowa - Henry B. Tippie College of Business - Department of Economics ( email )

108 Pappajohn Building
Iowa City, IA 52242
United States
319-335-0855 (Phone)

Ashish Tiwari (Contact Author)

University of Iowa ( email )

Finance Department
Henry B. Tippie College of Business, 108 PBB
Iowa City, IA 52242
United States
(319) 353-2185 (Phone)
(319) 335-3690 (Fax)

HOME PAGE: http://www.biz.uiowa.edu/faculty/atiwari

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