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Sentiment indices and their forecasting ability

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  • David A. Mascio
  • Frank J. Fabozzi

Abstract

The success of any timing strategy depends on the accuracy of market forecasts. In this paper, we test five indices to forecast the 1‐month‐ahead performance of the S&P 500 Index. These indices reflect investor sentiment, current business conditions, economic policy uncertainty, and market dislocation information. Each model is used in a logistic regression analysis to predict the 1‐month‐ahead market direction, and the forecasts are used to adjust the portfolio's beta. Beta optimization refers to a strategy designed to create a portfolio beta of 1.0 when the market is expected to go up, and a beta of −1.0 when a bear market is expected. Successful application of this strategy generates returns that are consistent with a call option or an option straddle position; that is, positive returns are generated in both up and down markets. Analysis reveals that the models' forecasts have discriminatory power in identifying substantial market movements, particularly during the bursting of the tech bubble and the financial crisis. Four of the five forecast models tested outperform the benchmark index.

Suggested Citation

  • David A. Mascio & Frank J. Fabozzi, 2019. "Sentiment indices and their forecasting ability," Journal of Forecasting, John Wiley & Sons, Ltd., vol. 38(4), pages 257-276, July.
    • Handle: RePEc:wly:jforec:v:38:y:2019:i:4:p:257-276
    DOI: 10.1002/for.2571
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    Cited by:

    1. David A. Mascio & Marat Molyboga & Frank J. Fabozzi, 2023. "The battle of the factors: Macroeconomic variables or investor sentiment?," Journal of Forecasting, John Wiley & Sons, Ltd., vol. 42(8), pages 2280-2291, December.
    2. David A. Mascio & Frank J. Fabozzi & J. Kenton Zumwalt, 2021. "Market timing using combined forecasts and machine learning," Journal of Forecasting, John Wiley & Sons, Ltd., vol. 40(1), pages 1-16, January.
    3. Yao, Can-Zhong & Li, Hong-Yu, 2020. "Time-varying lead–lag structure between investor sentiment and stock market," The North American Journal of Economics and Finance, Elsevier, vol. 52(C).

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