Forecasting Stock Returns with Large Dimensional Factor Models
46 Pages Posted: 26 Apr 2017 Last revised: 14 Jul 2021
Date Written: June 23, 2021
We study equity premium out-of-sample predictability by extracting the information contained
in a high number of macroeconomic predictors via large dimensional factor models. We compare the well-known factor model with a static representation of the common components with the Generalized Dynamic Factor Model, which accounts for time series dependence in the common components. Using statistical and economic evaluation criteria, we empirically show that the Generalized Dynamic Factor Model helps predicting the equity premium. Exploiting the link between business cycle and return predictability, we find accurate predictions also by combining rolling and recursive forecasts in real time.
Keywords: Stock Returns Forecasting, Factor Model, Large Data Sets, Forecast Evaluation.
JEL Classification: C38, C53, C55, G11, G17.
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