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How to Identify and Forecast Bull and Bear Markets?

77 Pages Posted: 22 Oct 2010  

Erik Kole

Erasmus University Rotterdam - Erasmus School of Economics - Econometric Institute; ERIM; Tinbergen Institute

Dick J. C. van Dijk

Erasmus University Rotterdam - Erasmus School of Economics - Econometric Institute; ERIM

Date Written: October 14, 2013

Abstract

The state of the equity market, often referred to as a bull or a bear market, is of key importance for financial decisions and economic analyses. Its latent nature has led to several methods to identify past and current states of the market and forecast future states. These methods encompass semi-parametric rule-based methods and parametric regime-switching models. We compare these methods by new statistical and economic measures that take into account the latent nature of the market state. The statistical measure is based directly on the predictions, while the economic mea- sure is based on the utility that results when a risk-averse agent uses the predictions in an investment decision. Our application of this framework to the S&P500 shows that rule-based methods are preferable for (in-sample) identification of the market state, but regime-switching models for (out-of-sample) forecasting. In-sample only the direction of the market matters, but for forecasting both means and volatilities of returns are important. Both the statistical and the economic measures indicate that these differences are significant.

Keywords: forecast evaluation, regime switching, stock market, economic comparison

Suggested Citation

Kole, Erik and van Dijk, Dick J. C., How to Identify and Forecast Bull and Bear Markets? (October 14, 2013). Paris December 2010 Finance Meeting EUROFIDAI - AFFI; ERIM Report Series Reference No. ERS-2013-016-F&A. Available at SSRN: https://ssrn.com/abstract=1695501

Erik Kole (Contact Author)

Erasmus University Rotterdam - Erasmus School of Economics - Econometric Institute ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands
+31 10 408 12 58 (Phone)

HOME PAGE: http://people.few.eur.nl/kole

ERIM

P.O. Box 1738
3000 DR Rotterdam
Netherlands

Tinbergen Institute ( email )

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

HOME PAGE: http://people.few.eur.nl/kole

Dick J.C. Van Dijk

Erasmus University Rotterdam - Erasmus School of Economics - Econometric Institute

P.O. Box 1738
3000 DR Rotterdam
Netherlands

ERIM ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands
+31 10 408 1263 (Phone)
+31 10 4089162 (Fax)

HOME PAGE: http://people.few.eur.nl/djvandijk

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