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| Author: | Pesarana, M.H. Timmermann, A. |
| Title: | Market timing and return prediction under model instability |
| Journal: | Journal of Empirical Finance
2002 : DEC, VOL. 9:5, p. 495-510 |
| Index terms: | Stock markets Forecasting Models USA |
| Language: | eng |
| Abstract: | Despite mounting empirical evidence to the contrary, the literature on predictability of stock returns almost uniformly assumes a time-invariant relationship btw. state variables and returns. This paper proposes a 2-stage approach for forecasting of financial return series that are subject to breaks. The first stage adopts a reversed ordered Cusum (ROC) procedure to determine in real time when the most recent break has occurred. In the second stage, post-break data is used to estimate the parameters of the forecasting model. This approach is compared to existing alternatives for dealing with parameter instability such as the BaiĀPerron method and the time-varying parameter (TVP) model. An out-of-sample forecasting experiment demonstrates considerable gains in market timing precision from adopting the proposed two-stage forecasting method. |
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