Forecasting Dynamic Return Distributions Based on Ordered Binary Choice

30 Pages Posted: 17 Nov 2017 Last revised: 9 Jan 2019

See all articles by Stanislav Anatolyev

Stanislav Anatolyev

New Economic School; CERGE-EI

Jozef Baruník

Charles University in Prague - Department of Economics; Institute of Information Theory and Automation, Prague

Date Written: November 15, 2017

Abstract

We present a simple approach to forecasting conditional probability distributions of asset returns. We work with a parsimonious specification of ordered binary choice regression that imposes a connection on sign predictability across different quantiles. The model forecasts the future conditional probability distributions of returns quite precisely when using a past indicator and past volatility proxy as predictors. Direct benefits of the model are revealed in an empirical application to the 29 most liquid U.S. stocks. The forecast probability distribution is translated to significant economic gains in a simple trading strategy. Our approach can also be useful in many other applications where conditional distribution forecasts are desired.

Keywords: asset returns, predictive distribution, conditional probability, probability forecasting, ordered binary choice

JEL Classification: C22, C58, G17

Suggested Citation

Anatolyev, Stanislav and Barunik, Jozef, Forecasting Dynamic Return Distributions Based on Ordered Binary Choice (November 15, 2017). Available at SSRN: https://ssrn.com/abstract=3071843 or http://dx.doi.org/10.2139/ssrn.3071843

Stanislav Anatolyev

New Economic School ( email )

Skolkovskoe shosse, 45
Moscow, 121353
Russia

CERGE-EI ( email )

P.O. Box 882
7 Politickych veznu
Prague 1, 111 21
Czech Republic

Jozef Barunik (Contact Author)

Charles University in Prague - Department of Economics ( email )

Opletalova 26
Prague 1, 110 00
Czech Republic

HOME PAGE: http://ies.fsv.cuni.cz/en/staff/barunik

Institute of Information Theory and Automation, Prague ( email )

Pod vodarenskou vezi 4
CZ-18208 Praha 8
Czech Republic

HOME PAGE: http://staff.utia.cas.cz/barunik/home.htm

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