The Economic Value of Predicting Stock Index Returns and Volatility

Posted: 4 Jan 2006

See all articles by Wessel Marquering

Wessel Marquering

Erasmus University Rotterdam (EUR) - Department of Financial Management

Marno Verbeek

Erasmus University - Rotterdam School of Management; Erasmus Research Institute of Management (ERIM); Netspar

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Abstract

In this paper, we analyze the economic value of predicting stock index returns as well as volatility. On the basis of simple linear models, estimated recursively, we produce out-of-sample forecasts for the return on the S&P 500 index and its volatility. Using monthly data, we examine the economic value of a number of alternative trading strategies over the period 1970-2001. It appears easier to forecast returns at times when volatility is high. For a mean-variance investor, this predictability is economically profitable, even if short sales are not allowed and transaction costs are quite large. The economic value of trading strategies that employ market timing in returns and volatility exceeds that of strategies that only employ timing in returns. Most of the profitability of the dynamic strategies, however, is located in the first half of our sample period.

Keywords: return forecasting, volatility, investing, asset allocation

JEL Classification: G11, G14

Suggested Citation

Marquering, Wessel A. and Verbeek, Marno, The Economic Value of Predicting Stock Index Returns and Volatility. Journal of Financial and Quantitative Analysis, Vol. 39, pp. 407-429, June 2004 , Available at SSRN: https://ssrn.com/abstract=873522

Wessel A. Marquering

Erasmus University Rotterdam (EUR) - Department of Financial Management ( email )

P.O. Box 1738
F4-26
Rotterdam 3000 DR
Netherlands
+31 10 408 2786 (Phone)
+31 10 408 9017 (Fax)

Marno Verbeek (Contact Author)

Erasmus University - Rotterdam School of Management ( email )

P.O. Box 1738
Room T09-53
3000 DR Rotterdam
Netherlands
+31 10 408 2790 (Phone)

HOME PAGE: http://www.rsm.nl/mverbeek

Erasmus Research Institute of Management (ERIM)

P.O. Box 1738
3000 DR Rotterdam
Netherlands

Netspar

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

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