Template-Type: ReDIF-Paper 1.0
Author-Name: Ravazzolo, F.
Author-Name-Last: Ravazzolo
Author-Name-First: Francesco
Author-Person: pra286
Author-Name: van Dijk, D.J.C.
Author-Name-Last: van Dijk
Author-Name-First: Dick
Author-Person: pva27
Author-Name: Paap, R.
Author-Name-Last: Paap
Author-Name-First: Richard
Author-Person: ppa494
Author-Name: Franses, Ph.H.B.F.
Author-Name-Last: Franses
Author-Name-First: Philip Hans
Author-Person: pfr226
Title: Bayesian Model Averaging in the Presence of Structural Breaks
Abstract: This paper develops a return forecasting methodology that allows for instabil ity in the relationship between stock returns and predictor variables, for model  uncertainty, and for parameter estimation uncertainty. The predictive regres sion speci¯cation that is put forward allows for occasional structural breaks  of random magnitude in the regression parameters, and for uncertainty about  the inclusion of forecasting variables, and about the parameter values by em ploying Bayesian Model Averaging. The implications of these three sources  of uncertainty, and their relative importance, are investigated from an active  investment management perspective. It is found that the economic value of  incorporating all three sources of uncertainty is considerable. A typical in vestor would be willing to pay up to several hundreds of basis points annually  to switch from a passive buy-and-hold strategy to an active strategy based on  a return forecasting model that allows for model and parameter uncertainty  as well as structural breaks in the regression parameters.
Creation-Date: 2006-08-24
File-URL: https://repub.eur.nl/pub/7904/EI%20Report%202006-33.pdf
File-Format: application/pdf
Series: RePEc:ems:eureir
Number: EI 2006-33
Classification-JEL: C11, G11, G12
Keywords: Bayesian model averaging, model uncertainty, portfolio selection, stock return predictability, structural breaks
Handle: RePEc:ems:eureir:7904