Predicting Long-Term Financial Returns: VAR vs. DSGE Model - A Horse-Race

53 Pages Posted: 3 Mar 2016 Last revised: 20 Jan 2017

See all articles by Eric Jondeau

Eric Jondeau

University of Lausanne - Faculty of Business and Economics (HEC Lausanne); Swiss Finance Institute

Michael Rockinger

University of Lausanne - School of Economics and Business Administration (HEC-Lausanne); Centre for Economic Policy Research (CEPR); Swiss Finance Institute

Date Written: January 18, 2017

Abstract

This paper considers an institutional investor who is implementing a long-term portfolio allocation strategy using forecasts of financial returns. We compare the performance of two competing macro-finance models, an unrestricted Vector AutoRegression (VAR) and a fully structural Dynamic Stochastic General Equilibrium (DSGE) model, at forecasting financial returns. We show that the DSGE model outperforms the unrestricted VAR at forecasting financial returns in the long term and generates substantially higher Sharpe ratios for mean-variance allocations. Even if it contains fewer unknown parameters, the DSGE model benefits from economically grounded restrictions that help anchor financial returns in the long term.

Keywords: VAR, DSGE model, Financial return forecasting, Long-term allocation

JEL Classification: C11, E44, G11

Suggested Citation

Jondeau, Eric and Rockinger, Georg Michael, Predicting Long-Term Financial Returns: VAR vs. DSGE Model - A Horse-Race (January 18, 2017). Swiss Finance Institute Research Paper No. 16-13. Available at SSRN: https://ssrn.com/abstract=2741141 or http://dx.doi.org/10.2139/ssrn.2741141

Eric Jondeau (Contact Author)

University of Lausanne - Faculty of Business and Economics (HEC Lausanne) ( email )

Extranef 232
Lausanne, 1012
Switzerland
+41 21 692 33 49 (Phone)

HOME PAGE: http://www.hec.unil.ch/ejondeau/

Swiss Finance Institute

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

Georg Michael Rockinger

University of Lausanne - School of Economics and Business Administration (HEC-Lausanne) ( email )

Unil Dorigny, Batiment Internef
Lausanne, 1015
Switzerland
+41 21 728 3348 (Phone)
+41+21 692 3435 (Fax)

HOME PAGE: http://www.hec.unil.ch/mrockinger

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Swiss Finance Institute

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

Register to save articles to
your library

Register

Paper statistics

Downloads
353
Abstract Views
1,688
rank
84,844
PlumX Metrics