Forecasting Stock Returns: Do Commodity Prices Help?
34 Pages Posted: 18 Jul 2014
Date Written: July 16, 2014
This paper examines the relationship between stock prices and commodity prices and whether this can be used to forecast stock returns. As both prices are linked to expected future economic performance they should exhibit a long-run relationship. Moreover, changes in sentiment towards commodity investing may affect the nature of the response to disequilibrium. Results support cointegration between stock and commodity prices, while Bai-Perron tests identify breaks in the predictive regression. Forecasts are computed using a standard fixed (static) in-sample/out-of-sample approach and by rolling regressions, which incorporates the effect of changing forecast parameter values. A range of model specifications and forecast metrics are used. The historical mean model outperforms the forecast models in the static approach. However, in the rolling forecasts, those models that incorporate information from the long-run stock price/commodity price relationship outperform both the historical mean and other forecast models. Of note, the historical mean still performs relatively well compared to standard forecast models that include the dividend yield and short term interest rates but not the stock/commodity price ratio.
Keywords: Stock Prices, Commodity Prices, Forecasting, Rolling
JEL Classification: C22, G12
Suggested Citation: Suggested Citation