Forecasting stock returns with large dimensional factor models

Giovannelli, Alessandro and Massacci, Daniele and Soccorsi, Stefano (2021) Forecasting stock returns with large dimensional factor models. Journal of Empirical Finance, 63. pp. 252-269. ISSN 0927-5398

Text (GMS2021_JEF_Revision_DM_AG_SS_rev_AG_June152021_app)
GMS2021_JEF_Revision_DM_AG_SS_rev_AG_June152021_app.pdf - Accepted Version
Available under License Creative Commons Attribution Non-commercial No Derivatives.
Download (3MB)

Abstract

We study equity premium out-of-sample predictability by extracting the information contained in a high number of macroeconomic predictors via large dimensional factor models. We compare the well-known factor model with a static representation of the common components with the Generalized Dynamic Factor Model, which accounts for time series dependence in the common components. Using statistical and economic evaluation criteria, we empirically show that the Generalized Dynamic Factor Model helps predicting the equity premium. Exploiting the link between business cycle and return predictability, we find accurate predictions also by combining rolling and recursive forecasts in real-time.