Does the Macroeconomy Predict U.K. Asset Returns in a Nonlinear Fashion? Comprehensive Out-of-Sample Evidence

We perform a comprehensive examination of the recursive, comparative predictive performance of a number of linear and non-linear models for UK stock and bond returns. We estimate Markov switching, threshold autoregressive (TAR), and smooth transition autoregressive (STR) regime switching models, and a range of linear specifications in addition to univariate models in which conditional heteroskedasticity is captured by GARCH type specifications and in which predicted volatilities appear in the conditional mean. The results demonstrate that U.K. asset returns require non-linear dynamics be modeled. In particular, the evidence in favour of adopting a Markov switching framework is strong. Our results appear robust to the choice of sample period, changes in the adopted loss function and to the methodology employed to test the null hypothesis of equal predictive accuracy across competing models. How to quote or cite this document Guidolin, M, Hyde, S, McMillan, D. and Ono, Sadayuki (2010). Does the Macroeconomy Predict U.K. Asset Returns in a Nonlinear Fashion? Comprehensive Out-of-Sample Evidence. Manchester Business School Working Paper, Number 607, available: http://www.mbs.ac.uk/research/working-papers.aspx. Does the Macroeconomy Predict U.K. Asset Returns in a Nonlinear Fashion? Comprehensive Out-of-Sample Evidence Massimo GUIDOLIN Manchester Business School Stuart HYDE∗ Manchester Business School David McMILLAN University of St. Andrews Sadayuki ONO University of York