Combination Forecasts of Bond and Stock Returns: An Asset Allocation Perspective

Abstract

We investigate the out-of-sample forecasting ability of the HML, SMB, momentum, short-term and long-term reversal factors along with their size and value decompositions on U.S. bond and stock returns for a variety of horizons ranging from the short run (1 month) to the long run (2 years). Our findings suggest that these factors contain significantly more information for future bond and stock market returns than the typically employed financial variables. Combination of forecasts of the empirical factors turns out to be particularly successful, especially from an an asset allocation perspective. Similar findings pertain to the European and Japanese markets.

Keywords: Combination forecasts, Fama French factors, Stock return predictability, Bond return predictability, Asset allocation

JEL Classification: C53, G11, G12