Forecasting stock market returns over multiple time horizons

Kroujiline, Dimitri and Gusev, Maxim and Ushanov, Dmitry and Sharov, Sergey V. and Govorkov, Boris (2015): Forecasting stock market returns over multiple time horizons. Forthcoming in: Quantitative Finance

Abstract

In this paper we seek to demonstrate the predictability of stock market returns and explain the nature of this return predictability. To this end, we introduce investors with different investment horizons into the news‐driven, analytic, agent‐based market model developed in Gusev et al. (2015). This heterogeneous framework enables us to capture dynamics at multiple timescales, expanding the model’s applications and improving precision. We study the heterogeneous model theoretically and empirically to highlight essential mechanisms underlying certain market behaviors, such as transitions between bull‐ and bear markets and the self‐similar behavior of price changes. Most importantly, we apply this model to show that the stock market is nearly efficient on intraday timescales, adjusting quickly to incoming news, but becomes inefficient on longer timescales, where news may have a long‐lasting nonlinear impact on dynamics, attributable to a feedback mechanism acting over these horizons. Then, using the model, we design algorithmic strategies that utilise news flow, quantified and measured, as the only input to trade on market return forecasts over multiple horizons, from days to months. The backtested results suggest that the return is predictable to the extent that successful trading strategies can be constructed to harness this predictability.

• Item Type: MPRA Paper
• Language: English
• Keywords: stock market dynamics, return predictability, price feedback, market efficiency, news analytics, sentiment evolution, agent-based models, Ising, dynamical systems, synchronization, self-similar behavior, regime transitions, news-based strategies, algorithmic trading
• Subjects: G - Financial Economics > G0 - General > G02 - Behavioral Finance: Underlying Principles; G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing ; Trading Volume ; Bond Interest Rates; G - Financial Economics > G1 - General Financial Markets > G14 - Information and Market Efficiency ; Event Studies ; Insider Trading; G - Financial Economics > G1 - General Financial Markets > G17 - Financial Forecasting and Simulation

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