Forecasting the direction of the US stock market with dynamic binary probit models |
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Authors: | Henri NybergAuthor Vitae |
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Affiliation: | Department of Political and Economic Studies, Economics, P.O. Box 17 (Arkadiankatu 7), FI-00014, University of Helsinki, Finland |
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Abstract: | Several empirical studies have documented that the signs of excess stock returns are, to some extent, predictable. In this paper, we consider the predictive ability of the binary dependent dynamic probit model in predicting the direction of monthly excess stock returns. The recession forecast obtained from the model for a binary recession indicator appears to be the most useful predictive variable, and once it is employed, the sign of the excess return is predictable in-sample. The new dynamic “error correction” probit model proposed in the paper yields better out-of-sample sign forecasts, with the resulting average trading returns being higher than those of either the buy-and-hold strategy or trading rules based on ARMAX models. |
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Keywords: | Dynamic probit model Directional predictability Stock return Recession forecast Leading indicators |
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