Evaluating the Predictive Distributions of Bayesian Models of Asset Returns

19 Pages Posted: 4 Jul 2008

See all articles by John Geweke

John Geweke

University of Technology Sydney - Economics Discipline Group

Gianni Amisano

Board of Governors of the Federal Reserve System; European Central Bank (ECB); University of Bologna - Rimini Center for Economic Analysis (RCEA); University of Brescia - Department of Economics

Date Written: June 30, 2008

Abstract

Bayesian time series models provide exact, out-of-sample predictive distributions. This paper examines two approaches to the comparison and evaluation of these distributions and illustrates them using five alternative models of asset returns applied to the daily S&P 500 index from 1976 through 2005. It is shown that the first approach, using predictive likelihoods, is intimately related to Bayes factors. The illustration shows how analysis of predictive likelihoods provides insight into the relative strengths and weaknesses of alternative prediction models. The second approach, using the probability integral transform, provides absolute standards in the evaluation of the quality of predictive distributions. The illustration shows that the two approaches can be complementary, each identifying strengths and weaknesses in the model that are not evident using the other. For the S&P 500 data, the predictive distributions of the hierarchical Markov normal mixture model prove superior to those of a stochastic volatility model and several models in the ARCH family.

Keywords: forecasting, GARCH, inverse probability transform, Markov mixture, predictive likelihood, S&P 500 returns, stochastic volatility

JEL Classification: C53, G12, C11

Suggested Citation

Geweke, John and Amisano, Gianni, Evaluating the Predictive Distributions of Bayesian Models of Asset Returns (June 30, 2008). Available at SSRN: https://ssrn.com/abstract=1154496 or http://dx.doi.org/10.2139/ssrn.1154496

John Geweke (Contact Author)

University of Technology Sydney - Economics Discipline Group ( email )

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HOME PAGE: http://www.censoc.uts.edu.au/about/members/jgeweke_papers.html

Gianni Amisano

Board of Governors of the Federal Reserve System

20th Street and Constitution Avenue NW
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United States

European Central Bank (ECB) ( email )

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University of Bologna - Rimini Center for Economic Analysis (RCEA) ( email )

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Rimini (RN), RN 47900
Italy

University of Brescia - Department of Economics ( email )

Via San Faustino 74B
Brescia, 25122
Italy

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