TY - JOUR

T1 - Equity Premium Forecasts with an Unknown Number of Structural Breaks

AU - Smith, Simon C.

AU - Bulkley, George

AU - Leslie, David S.

PY - 2020/1/1

Y1 - 2020/1/1

N2 - Estimation of models with structural breaks usually assumes a pre-specified number of breaks. Previous models which do allow an endogenously determined number of breaks require a simple structural model, and rarely allow for information transfer across the break. We introduce a methodology that allows the number of breaks to be determined endogenously and including an economically motivated model of transition regimes between each break. We demonstrate the usefulness of our approach for forecasts of the equity premium. We find the demonstrated success of the historical average can be improved upon by an economic model with theory informed priors estimated using our methodology.

AB - Estimation of models with structural breaks usually assumes a pre-specified number of breaks. Previous models which do allow an endogenously determined number of breaks require a simple structural model, and rarely allow for information transfer across the break. We introduce a methodology that allows the number of breaks to be determined endogenously and including an economically motivated model of transition regimes between each break. We demonstrate the usefulness of our approach for forecasts of the equity premium. We find the demonstrated success of the historical average can be improved upon by an economic model with theory informed priors estimated using our methodology.

KW - equity premium

KW - structural breaks

KW - forecasting

KW - Bayesian

KW - MULTIPLE CHANGE-POINT

KW - TIME-SERIES

KW - INFERENCE

KW - MODELS

KW - SAMPLE

KW - PREDICTABILITY

KW - COMPUTATION

KW - INSTABILITY

U2 - 10.1093/jjfinec/nby034

DO - 10.1093/jjfinec/nby034

M3 - Journal article

VL - 18

SP - 59

EP - 94

JO - Journal of Financial Econometrics

JF - Journal of Financial Econometrics

SN - 1479-8409

IS - 1

ER -