Forecasting Stock Returns in Good and Bad Times: The Role of Market States

41 Pages Posted: 14 Dec 2012 Last revised: 1 Aug 2017

See all articles by Dashan Huang

Dashan Huang

Singapore Management University - Lee Kong Chian School of Business

Fuwei Jiang

Central University of Finance and Economics (CUFE)

Jun Tu

Singapore Management University - Lee Kong Chian School of Business

Guofu Zhou

Washington University in St. Louis - John M. Olin Business School; China Academy of Financial Research (CAFR)

Date Written: July 31, 2017

Abstract

This paper proposes a two-state predictive regression model and shows that stock market 12-month return (TMR), the time-series momentum predictor of Moskowitz, Ooi, and Pedersen (2012), forecasts the aggregate stock market negatively in good times and positively in bad times. The out-of-sample R-squares are 0.96% and 1.72% in good and bad times, or 1.28% and 1.41% in NBER economic expansions and recessions, respectively. The TMR predictability pattern holds in the cross-section of U.S. stocks and the international markets. Our study shows that the absence of return predictability in good times, an important finding of recent studies, is largely driven by the use of the popular one-state predictive regression model.

Keywords: Return predictability; Mean reversion; Momentum; Market risk premium; Leading economic indicator; 200-day moving average; Business cycle

JEL Classification: C53, C58, G12, G14, G17

Suggested Citation

Huang, Dashan and Jiang, Fuwei and Tu, Jun and Zhou, Guofu, Forecasting Stock Returns in Good and Bad Times: The Role of Market States (July 31, 2017). 27th Australasian Finance and Banking Conference 2014 Paper; Asian Finance Association (AsianFA) 2016 Conference. Available at SSRN: https://ssrn.com/abstract=2188989 or http://dx.doi.org/10.2139/ssrn.2188989

Dashan Huang (Contact Author)

Singapore Management University - Lee Kong Chian School of Business ( email )

50 Stamford Road
Singapore, 178899
Singapore

HOME PAGE: http://dashanhuang.weebly.com/

Fuwei Jiang

Central University of Finance and Economics (CUFE) ( email )

39 South College Road
Haidian District
Beijing, Beijing 100081
China

Jun Tu

Singapore Management University - Lee Kong Chian School of Business ( email )

50 Stamford Road
#04-01
Singapore, 178899
Singapore

Guofu Zhou

Washington University in St. Louis - John M. Olin Business School ( email )

Washington University
Campus Box 1133
St. Louis, MO 63130-4899
United States
314-935-6384 (Phone)
314-658-6359 (Fax)

HOME PAGE: http://apps.olin.wustl.edu/faculty/zhou/

China Academy of Financial Research (CAFR)

Shanghai Advanced Institute of Finance
Shanghai P.R.China, 200030
China

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