Forecasting Stock Market Returns: The Sum of the Parts is More than the Whole

57 Pages Posted: 19 Aug 2010

See all articles by Miguel A. Ferreira

Miguel A. Ferreira

Nova School of Business and Economics; European Corporate Governance Institute (ECGI); Centre for Economic Policy Research (CEPR)

Pedro Santa-Clara

Nova School of Business and Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 3 versions of this paper

Date Written: August 18, 2010

Abstract

We propose forecasting separately the three components of stock market returns: the dividend-price ratio, earnings growth, and price-earnings ratio growth - the sum-of-the-parts (SOP) method. Our method exploits the different time-series persistence of the components and obtains out-of-sample R-squares (compared to the historical mean) of more than 1.3% with monthly data and 13.4% with yearly data. This compares with typically negative R-squares obtained in a similar experiment with predictive regressions. The performance of the SOP method comes mainly from the dividend-price ratio and earnings growth components and the robustness of the method is due to its low estimation error. An investor who timed the market using our method would have had a Sharpe ratio gain of 0.3.

Suggested Citation

Ferreira, Miguel Almeida and Santa-Clara, Pedro, Forecasting Stock Market Returns: The Sum of the Parts is More than the Whole (August 18, 2010). Journal of Financial Economics (JFE), Forthcoming, Available at SSRN: https://ssrn.com/abstract=1661006

Miguel Almeida Ferreira (Contact Author)

Nova School of Business and Economics ( email )

Campus de Carcavelos
Rua da Holanda, 1
Carcavelos, 2775-405
Portugal

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Pedro Santa-Clara

Nova School of Business and Economics ( email )

Campus de Carcavelos
Rua da Holanda, 1
Carcavelos, 2775-405
Portugal

HOME PAGE: http://docentes.fe.unl.pt/~psc/

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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