Forecasting Stock Market Returns in Europe

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Are European stock market returns predictable? In their September 2012 paper entitled “Forecasting Returns: New European Evidence”, Steven Jordan, Andrew Vivian and Mark Wohar test the ability of fundamental, macroeconomic and technical variables to predict next-month returns in 14 developed and emerging European country stock markets both in-sample and out-of-sample. They consider four fundamental variables (using logarithms): dividend-price ratio; dividend yield; earnings-price ratio; and, dividend payout ratio (dividend-to-earnings). They consider two macroeconomic variables: the risk-free rate; and, variance of weekly stock market returns over the last 52 weeks. They consider two technical variables: monthly price pressure (ratio of number of rising stocks to number of falling stocks); and, monthly change in volume of all stocks. They test predictive power via simple linear regression, with a rolling historical window of 60 months for out-of-sample tests. They use the historical average as a benchmark forecast. To assess the economic value of forecasts, they examine whether portfolio allocations based on regression outputs beat those based on the historical average. Using monthly data for 14 European/Mediterranean stock market indexes during January 1995 (so out-of-sample tests begin in 2000) through December 2011, they find that: (more…)

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