Do Combination Forecasts Outperform the Historical Average? Economic and Statistical Evidence

This paper examines the out-of-sample predictability of monthly German stock returns, and addresses the issue of whether combinations of individual model forecasts are able to provide significant out-of-sample gains relative to the historical average. Empirical analysis over the period from 1973 to 2012 implies that firstly, the term spread has the in-sample ability to predict stock returns, secondly, and most importantly, this variable successfully delivers consistent out-of-sample forecast gains relative to the historical average, and thirdly, combination forecasts do not appear to offer a significant evidence of consistently beating the historical average forecasts of the stock returns. Results are robust using both statistical and economic criteria, and hold across different out-of-sample forecast evaluation periods.