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Real‐Time Detection of Regimes of Predictability in the U.S. Equity Premium

Harvey, David I.; Leybourne, Stephen J.; Sollis, Robert; Taylor, A.M. Robert

Authors

Robert Sollis

A.M. Robert Taylor



Abstract

We propose new real-time monitoring procedures for the emergence of end-of-sample predictive regimes using sequential implementations of standard (heteroskedasticity-robust) regression t-statistics for predictability applied over relatively short time periods. The procedures we develop can also be used for detecting historical regimes of temporary predictability. Our proposed methods are robust to both the degree of persistence and endogeneity of the regressors in the predictive regression and to certain forms of heteroskedasticity in the shocks. We discuss how the monitoring procedures can be designed such that their false positive rate can be set by the practitioner at the start of the monitoring period using detection rules based on information obtained from the data in a training period. We use these new monitoring procedures to investigate the presence of regime changes in the predictability of the U.S. equity premium at the one-month horizon by traditional macroeconomic and financial variables, and by binary technical analysis indicators. Our results suggest that the one-month ahead equity premium has temporarily been predictable, displaying so-called ‘pockets of predictability’, and that these episodes of predictability could have been detected in real-time by practitioners using our proposed methodology.

Journal Article Type Article
Publication Date Jul 6, 2020
Journal Journal of Applied Econometrics
Print ISSN 0883-7252
Electronic ISSN 1099-1255
Publisher Wiley
Peer Reviewed Peer Reviewed
APA6 Citation Harvey, D. I., Leybourne, S. J., Sollis, R., & Taylor, A. R. (2020). Real‐Time Detection of Regimes of Predictability in the U.S. Equity Premium. Journal of Applied Econometrics, https://doi.org/10.1002/jae.2794
DOI https://doi.org/10.1002/jae.2794
Keywords Predictive regression, Persistence, Temporary predictability, Subsampling, U.S. equity premium
Publisher URL https://onlinelibrary.wiley.com/doi/10.1002/jae.2794
Additional Information This is the peer reviewed version of the following article: Harvey, D. I., Leybourne, S. J., Sollis, R., & Taylor, A. R. (2020). Real‐Time Detection of Regimes of Predictability in the U.S. Equity Premium. Journal of Applied Econometrics, which has been published in final form at https://doi.org/10.1002/jae.2794. This article may be used for non-commercial purposes in accordance with Wiley Terms and Conditions for Use of Self-Archived Versions
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