Predicting equity premium out-of-sample by conditioning on newspaper-based uncertainty measures: A comparative study |
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Affiliation: | 1. Department of Mathematics and School of Economics and Management, University of Bologna, Bologna, Italy;2. Department of Economics, Society and Politics, University of Urbino Carlo Bo, Italy;3. Department of Economics, University of Bamberg, Germany;1. Faculty of Business, City University of Macau, Macau, China;2. School of Business, Macau University of Science and Technology, Macau, China;1. Department of Accountancy and Finance at University of Antwerp, Stadscampus Prinsstraat 13 S.B.329, 2000 Antwerpen, Belgium;2. College of Business, University of Akron, Akron, OH, USA;3. School of Accounting and Finance, University of Vaasa, Wolffintie 34, 65200 Vaasa, Finland;4. Department of Data Science, Economics and Finance at EDHEC Business School, 24 avenue Gustave Delory, 59057 Roubaix Cedex 1, France;1. School of Accounting, Zhongnan University of Economics and Law, 182 Nanhu Avenue, Wuhan, China;3. School of Accountancy, Shanghai University of Finance and Economics, 777 Guoding Road, Shanghai, China;4. Research Center of Finance, Shanghai Business School, 123 Fengpu Avenue, Shanghai, China |
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Abstract: | In finance, the use of newspaper-based uncertainty measures has grown exponentially in recent years. For instance, a growing number of researchers have used the newspaper-based U.S. economic policy uncertainty (EPU) index suggested in Baker et al. (2016) as a predictor in their model to forecast the variable of interest out-of-sample. Likewise, inspired by the approach suggested in Baker et al. (2016), several other newspaper-based uncertainty measures have been introduced, such as indices measuring geopolitical risk (GPR) and monetary policy uncertainty (MPU). This study evaluates the relative out-of-sample predictive power afforded by more than fifty different newspaper-based uncertainty measures with regards to predicting excess returns on the S&P 500 index one-month ahead using data from 19851 through 202012. Our predictive model accounts for salient data features, namely, predictor endogeneity and persistence. Furthermore, we evaluate the evidence of conditional as well unconditional predictive ability as outlined in Giacomini and White (2006), and also explore whether any identified level of gains from a statistical viewpoint lead to gains from an economic viewpoint. We find that newspaper-based uncertainty measures linked with certain components of the equity market volatility (EMV) tracker suggested in Baker et al. (2019) help improve the accuracy of one month ahead point predictions relative to the benchmark the most. In contrast, EPU, GPR and MPU indices, which are more frequently used by researchers are much less successful. |
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Keywords: | Equity premium prediction Newspaper-based uncertainty measures Out-of-sample predictability Portfolio optimization |
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