In this paper, we analyze the economic value of predicting stock index returns as well as volatility. On the basis of simple linear models, estimated recursively, we produce genuine out-of-sample forecasts for the return on the S&P 500 index and its volatility. Using monthly data from 1954 to 2001, we test the statistical significance of return and volatility predictability and examine the economic value of a number of alternative trading strategies. While we find strong evidence for market timing in both returns and volatility, the success of market timing and volatility timing varies considerably over the sample period. Further, it appears easier to forecast returns at times when volatility is high. For a mean-variance investor, this predictability is economically profitable, even if short sales are not allowed and transaction costs are quite large. The economic value of trading strategies that employ market timing in returns and volatility exceeds that of strategies that only employ timing in returns.

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Erasmus Research Institute of Management
hdl.handle.net/1765/133
ERIM Report Series Research in Management
Erasmus Research Institute of Management

Marquering, W.A, & Verbeek, M.J.C.M. (2001). The Economic Value of Predicting Stock Index Returns and Volatility (No. ERS-2001-75-F&A). ERIM Report Series Research in Management. Erasmus Research Institute of Management. Retrieved from http://hdl.handle.net/1765/133