Regime Shifts and Stock Return Predictability

International Review of Economics and Finance, Vol. 56, Issue C, July 2018, pp. 138-160

50 Pages Posted: 4 Jun 2014 Last revised: 6 Aug 2019

See all articles by Regina Hammerschmid

Regina Hammerschmid

University of Zurich; Swiss Finance Institute

Harald Lohre

Robeco Quantitative Investments; Lancaster University Management School

Date Written: November 15, 2017

Abstract

Identifying economic regimes is useful in a world of time-varying risk premia. We apply regime switching models to common factors proxying for the macroeconomic regime and show that the ensuing regime factor is relevant in forecasting the equity risk premium. Moreover, the relevance of this regime factor is preserved in the presence of fundamental variables and technical indicators which are known to predict equity risk premia. Based on multiple predictive regressions and pooled forecasts, the macroeconomic regime factor is deemed complementary relative to the fundamental and technical information sets. Finally, these forecasts exhibit significant out-of-sample predictability that ultimately translates into considerable utility gains in a mean-variance portfolio strategy.

Keywords: Return Predictability, Regime Switching, Predictive Regressions

JEL Classification: G11, G12, G17

Suggested Citation

Hammerschmid, Regina and Lohre, Harald, Regime Shifts and Stock Return Predictability (November 15, 2017). International Review of Economics and Finance, Vol. 56, Issue C, July 2018, pp. 138-160, Available at SSRN: https://ssrn.com/abstract=2445086 or http://dx.doi.org/10.2139/ssrn.2445086

Regina Hammerschmid (Contact Author)

University of Zurich ( email )

Sch├Ânberggasse 1
Z├╝rich, 8001
Switzerland

Swiss Finance Institute ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Harald Lohre

Robeco Quantitative Investments ( email )

Weena 850
Rotterdam, 3011 AG
Netherlands

Lancaster University Management School

Bailrigg
Lancaster LA1 4YX
United Kingdom

HOME PAGE: http://www.lancaster.ac.uk/lums/people/harald-lohre

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