Evaluation of forecasting methods from selected stock market returns

M Mallikarjuna,R Prabhakara Rao

doi:10.1186/s40854-019-0157-x

M Mallikarjuna, R Prabhakara Rao

Open Access

https://doi.org/10.1186/s40854-019-0157-x

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Abstract

Forecasting stock market returns is one of the most effective tools for risk management and portfolio diversification. There are several forecasting techniques in the literature for obtaining accurate forecasts for investment decision making. Numerous empirical studies have employed such methods to investigate the returns of different individual stock indices. However, there have been very few studies of groups of stock markets or indices. The findings of previous studies indicate that there is no single method that can be applied uniformly to all markets. In this context, this study aimed to examine the predictive performance of linear, nonlinear, artificial intelligence, frequency domain, and hybrid models to find an appropriate model to forecast the stock returns of developed, emerging, and frontier markets. We considered the daily stock market returns of selected indices from developed, emerging, and frontier markets for the period 2000–2018 to evaluate the predictive performance of the above models. The results showed that no single model out of the five models could be applied uniformly to all markets. However, traditional linear and nonlinear models outperformed artificial intelligence and frequency domain models in providing accurate forecasts.

Highlights

Theoretical and empirical studies have shown that a positive relationship exists between financial markets and economic growth (e.g., Levine, 1997; Rajan and Zingales, 1998; Rousseau and Watchel, 2000; Beck et al, 2003; Guptha and Rao, 2018)
To test the stationarity of the returns series, we employed the augmented Dickey–Fuller (1979) and Phillips–Perron (1988) tests; the results showed that the returns of all of the markets were stationary
Forecasting techniques can help with better investment decision making

Summary

Introduction

Theoretical and empirical studies have shown that a positive relationship exists between financial markets and economic growth (e.g., Levine, 1997; Rajan and Zingales, 1998; Rousseau and Watchel, 2000; Beck et al, 2003; Guptha and Rao, 2018). Given the significance of financial markets, forecasting financial returns occupies a paramount position in investment decision making. Movements in stock markets are influenced by several factors, such as macro-economic factors, international events, and human behavior. The profitability of investments in stock markets highly depends on the predictability of stock movements. If a forecasting model or technique can precisely predict the direction of the market, investment risk and uncertainty can be minimized. It would enhance investment flows into stock

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