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Further evidence on bear market predictability: The role of the external finance premium

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  • Chen, Nan-Kuang
  • Chen, Shiu-Sheng
  • Chou, Yu-Hsi

Abstract

This paper revisits bear market predictability by employing a number of variables widely used in forecasting stock returns. In particular, we focus on variables related to the presence of imperfect credit markets. We evaluate prediction performance using in-sample and out-of-sample tests. Empirical evidence from the US stock market suggests that among the variables we investigate, the default yield spread, inflation, and the term spread are useful in predicting bear markets. Further, we find that the default yield spread provides superior out-of-sample predictability for bear markets one to three months ahead, which suggests that the external finance premium has an informative content on the financial market.

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  • Chen, Nan-Kuang & Chen, Shiu-Sheng & Chou, Yu-Hsi, 2017. "Further evidence on bear market predictability: The role of the external finance premium," International Review of Economics & Finance, Elsevier, vol. 50(C), pages 106-121.
    • Handle: RePEc:eee:reveco:v:50:y:2017:i:c:p:106-121
    DOI: 10.1016/j.iref.2017.03.019
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    2. Hammerschmid, Regina & Lohre, Harald, 2018. "Regime shifts and stock return predictability," International Review of Economics & Finance, Elsevier, vol. 56(C), pages 138-160.

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    Keywords

    Bear markets; Stock returns; Markov-switching model;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods

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