Working Paper BETA #2019-24

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Title : Memory that Drives! New Insights into Forecasting Performance of Stock Prices from SEMIFARMA-AEGAS Model

Author(s) : Mohamed Chikhi, Claude Diebolt, Tapas Mishra

Abstract : Stock price forecasting, a popular growth-enhancing exercise for investors, is inherently complex – thanks to the interplay of financial economic drivers which determine both the magnitude of memory and the extent of non-linearity within a system. In this paper, we accommodate both features within a single estimation framework to forecast stock prices and identify the nature of market efficiency commensurate with the proposed model. We combine a class of semiparametric autoregressive fractionally integrated moving average (SEMIFARMA) model with asymmetric exponential generalized autoregressive score (AEGAS) errors to design a SEMIRFARMA-AEGAS framework based on which predictive performance of this model is tested against competing methods. Our conditional variance includes leverage effects, jumps and fat tail-skewness distribution, each of which affects magnitude of memory in a stock price system. A true forecast function is built and new insights into stock price forecasting are presented. We estimate several models using the Skewed Student-t maximum likelihood and find that the informational shocks have permanent effects on returns and the SEMIFARMA-AEGAS is appropriate for capturing volatility clustering for both negative (long Value-at-Risk) and positive returns (short Value-at-Risk). We show that this model has better predictive performance over competing models for both long and/or some short time horizons. The predictions from SEMIRFARMA-AEGAS model beats comfortably the random walk model. Our results have implications for market-efficiency: the weak efficiency assumption of financial markets stands violated for all stock price returns studied over a long period.

Key-words : Stock price forecasting; SEMIFARMA model; AEGAS model; Skewed Student-t maximum likelihood; Asymmetry; Jumps.

JEL Classification : C14, C58, C22, G17