Research Note: The Economic Benefit of Forecasting Market Components for Mean-Variance Investors

Abstract

Existing studies focus on variables’ predictive quality with respect to the aggregated stock market, which per definition contains a minimum level of idiosyncratic risk and provides a favorable environment for such applications. Economic intuition suggests that the level of out-of-sample predictability decreases as we climb down the ladder from market aggregates to industries and ultimately single stock returns. Thereon, we ask the central question:

Do forecasting errors from direct predictions of market components out-way the additional errors introduced by an intermediary asset pricing model?

This is an early stage research note and we welcome any feedback and comments.

Keywords: out-of-sample return predictability, industry portfolios, CAPM, empirical mean, market implied returns

JEL Classification: G17