Econometric Modeling of Stock Market Returns: A Guide for Active Management

Abstract

The paper provides an introductory guide for active managers that illustrates econometric techniques for alpha generation in active asset management. For modelling stock market returns three different model types are discussed: (i) fair value models that identify over- and undervaluations, (ii) explanatory return models that allow for scenario forecasting and iii) forecasting models that provide implementable investment signals. We provide illustrative examples for SP500 data and show how active managers may integrate these models in their investment processes. Our results indicate the relevance of econometric models to add value in active management.

Keywords: Stock Markets, Fair Value, Forecasting, Econometric Modeling

JEL Classification: C58, G12, G17