This thesis delivers a comprehensive study on the empirical performance of the market returns on the UK equity market. It particularly focuses on the aggregate market indices to gain a complete look at the UK market. Different economic variables, such as fundamental stock characteristics, business cycle variables, the sentiment variable, and macroeconomic indicators, are investigated to determine their impact on the equity market return.
The initial data set analysed covers the period from January 1990 to September 2020. During this sample period, several significant economic and political events occurred. One notable event is the severe economic downturn in the UK induced by the 2008 global financial crisis, from which it took years for the economy to recover. However, the British exit from the European Union (Brexit), triggered by a nationwide referendum in 2016, brought economic uncertainties back.
Since early 2020, countries worldwide have suffered from the COVID-19 pandemic, and the global economy has faced a serious challenge. The lockdown and other restrictions made to tackle the pandemic have caused a significant slump in economic output, especially in the UK, as its economy depends mainly on services industries.
Accordingly, all these events have had a significant negative impact on the UK equity markets. In order to make more robust inferences about the predictive ability of various economic variables, two forecast periods are considered instead of one. One forecast period covers the period from January 2001 to September 2020, and the other covers the more recent ten years from January 2011 to September 2020.
Table of Contents
1 Introduction
2 Literature Review
2.1 The History of Research on Equity Market Prediction
2.2 The Debate about Equity Market Prediction
2.3 Findings with New Variables in More Recent Research
2.4 Literature Regarding the UK Market
3 Data and Summary Statistics
3.1 Data Source and Data Construction
3.2 Summary Statistics
4 In-sample Return Predictions
4.1 Predictive Regression Model
4.2 Predictive Regression Results
4.2.1 Univariate Regression Results
4.2.2 Multivariate Regression Results
5 Out-of-sample Return Forecasts
5.1 Empirical Procedure
5.2 Forecast Evaluation
5.3 Out-of-sample Forecasting Performance
6 Summary and Conclusion
Research Objectives and Topics
This thesis investigates the empirical predictability of excess market returns in the United Kingdom equity market. By employing a comprehensive set of 14 economic variables—ranging from fundamental stock characteristics to macroeconomic indicators—the research aims to determine whether these variables can systematically forecast market returns and outperform a benchmark model based on historical averages.
- Analysis of in-sample predictive regression models to identify significant return predictors in the UK market.
- Evaluation of out-of-sample forecasting performance to test the robustness of identified predictors across different time periods.
- Investigation of the impact of major economic and political events, such as the 2008 financial crisis, Brexit, and the COVID-19 pandemic, on market return predictability.
- Comparison of various economic variables including dividend-to-price ratios, term spreads, and consumption-wealth-income ratios.
Excerpt from the Book
2 Literature Review
The question of predictability of the equity market has received much interest and contention from academics and investors who are intrinsically motivated to learn how the market will move in the future. Previous research appears to show that there is a link between economic indicators and stock market performance. Yet, some more recent studies point out illusory predictability. The equity market predictability is still a controversial issue.
2.1 The History of Research on Equity Market Prediction
There exists a vast amount of literature on the predictability of the equity market, and it covers a range of different variables, methodologies, and sample periods. A preliminary study regarding market return predictivity is carried out by Dow (1920), in which he proposes that the dividend yield helps predict stock returns. Around the early 1970s, the theory of market efficiency (also known as the market efficient hypothesis) emerged. This theory defines the market as random so that the investors could benefit little from neither technical nor fundamental analysis. Fama (1970) supports this point of view and suggests that future returns are hardly predictable because all available relevant information is already contained in the market prices.
Summary of Chapters
1 Introduction: Provides an overview of the stock market as a fundamental source of corporate financing and introduces the motivation behind studying market return predictability, specifically focusing on the UK context.
2 Literature Review: Synthesizes existing academic research on market predictability, covering the historical debate and the findings of modern studies regarding specific economic variables in both US and UK markets.
3 Data and Summary Statistics: Details the primary data sources, the construction of the 14 explanatory variables, and presents descriptive statistics for the variables used in the predictive models.
4 In-sample Return Predictions: Explains the multiperiod forecasting regression model and presents the results of univariate and multivariate regressions to determine if any variables significantly predict market returns.
5 Out-of-sample Return Forecasts: Discusses the empirical procedure for out-of-sample testing and evaluates whether the identified predictors hold their forecasting power when applied to real-time scenarios.
6 Summary and Conclusion: Recaps the main empirical findings of the thesis and discusses the implications regarding the unsettled nature of equity market predictability in the UK.
Keywords
Equity Market, Return Predictability, UK Market, Dividend Yield, Predictive Regression, In-sample Prediction, Out-of-sample Forecast, Financial Crisis, Macroeconomic Indicators, Market Efficiency, Consumption-Wealth-Income Ratio, Investor Sentiment, Statistical Significance, Forecasting Horizon, Capital Markets
Frequently Asked Questions
What is the fundamental objective of this thesis?
The thesis aims to assess whether various economic variables can successfully predict future excess market returns in the United Kingdom, specifically by analyzing both in-sample and out-of-sample forecasting performance.
What are the core thematic areas covered?
The core themes include fundamental stock valuation ratios, business cycle indicators, investor sentiment, and macroeconomic variables, analyzed through the lens of modern financial econometrics.
What is the primary research question?
The research seeks to answer whether the equity market in the UK is predictable given a set of known economic variables, and if such predictability persists in out-of-sample tests.
Which scientific methods are employed?
The study utilizes ordinary least squares (OLS) predictive regression models and evaluates forecasting performance through the adjusted mean squared prediction error (MSPE) and realized utility gain.
What does the main body address?
The main body systematically explores data construction, performs univariate and multivariate in-sample regressions, and conducts out-of-sample tests across different forecasting periods to check for model robustness.
Which keywords characterize this work?
Key terms include Equity Market, Return Predictability, UK Market, Dividend Yield, Predictive Regression, and Forecasting Performance.
How do significant economic events like Brexit influence the research?
These events provide critical contexts during the sample period, prompting the author to use multiple forecast periods to ensure the robustness of the predictive models against external shocks.
Why does the thesis evaluate the out-of-sample performance?
Out-of-sample evaluation is necessary because significant in-sample results may be a product of over-fitting; thus, real-time testing is required to verify if a model can genuinely deliver value to investors.
- Arbeit zitieren
- Hanlu Diao (Autor:in), 2021, Equity Market Prediction. Evidence from the United Kingdom, München, GRIN Verlag, https://www.grin.com/document/1127974
