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Regime Shifts and Stock Return Predictability

48 Pages Posted: 4 Jun 2014 Last revised: 31 Jan 2017

Regina Hammerschmid

University of Zurich

Harald Lohre

Invesco; Centre for Financial Econometrics, Asset Markets and Macroeconomic Policy, Lancaster University Management School

Date Written: January 30, 2017

Abstract

Identifying economic regimes ought to be useful in a world of time-varying risk premia. We apply regime switching models to common factors proxying for the macroeconomic regime and document the ensuing regime factor to be relevant in forecasting returns when using a predictive regression. Moreover, the relevance of this regime factor is preserved in the presence of fundamental variables and technical indicators 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 and gives rise to significant out-of-sample predictability that ultimately translates to 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 (January 30, 2017). 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 )

Schönberggasse 1
Zürich, 8001
Switzerland

Centre for Financial Econometrics, Asset Markets and Macroeconomic Policy, Lancaster University Management School

Bailrigg
Lancaster LA1 4YX
United Kingdom

HOME PAGE: http://www.lancaster.ac.uk/lums/research/research-centres/financial-econometrics/

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