Forecast Ranked Tailored Equity Portfolios
38 Pages Posted: 2 Jan 2019 Last revised: 31 Jul 2019
Date Written: July 30, 2019
We use a dynamic model averaging (DMA) approach to construct forecasts of individual equity returns for a large cross-section of stocks contained in the SP500, FTSE100, DAX30, CAC40 and SPX30 headline indices, taking value, momentum, and quality factors as predictor variables. Fixing the set of ‘forgetting factors’ in the DMA prediction framework, we show that highly significant return forecasts relative to the historic average benchmark are obtained for 173 (281) individual equities at the 1% (5%) level, from a total of 895 stocks. These statistical forecast improvements also translate into considerable economic gains, producing out-of-sample R2 values above 5% (10%) for 283 (166) of the 895 individual stocks. Equally weighted long only portfolios constructed from a ranking of the best 25% forecasts in each headline index can generate sizable returns in excess of a passive investment strategy in that index itself, even when transaction costs and risk taking are accounted for.
Keywords: active factor models, model averaging and selection, computational finance, quantitative equity investing, stock selection strategies, return-based factor models
JEL Classification: C11, C52, G11, G15, G17, F37
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