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Predicting the direction of US stock markets using industry returns

Pönkä, Harri (2014): Predicting the direction of US stock markets using industry returns.

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Abstract

In this paper, we examine the directional predictability of excess stock market returns by lagged excess returns from industry portfolios and a number of other commonly used variables by means of dynamic probit models. We focus on the directional component of the market returns because, for investment purposes, forecasting the direction of return correctly is presumably more relevant than the accuracy of point forecasts. Our findings suggest that only a small number of industries have predictive power for market returns. We also find that the binary response models outperform conventional predictive regressions in forecasting the direction of the market return. Finally, we test trading strategies and find that a number of industry portfolios contain information that can be used to improve investment returns.

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