Balancing model structure and flexibility in forecasting financial time series

dc.contributor.advisorCarvalho, Carlos Marinho, 1978-
dc.contributor.committeeMemberMurray, Jared S
dc.contributor.committeeMemberPettenuzzo, Davide
dc.contributor.committeeMemberShively, Thomas S
dc.creatorFisher, Jared Dale
dc.creator.orcid0000-0002-0369-9203
dc.date.accessioned2019-07-01T18:31:34Z
dc.date.available2019-07-01T18:31:34Z
dc.date.created2019-05
dc.date.issued2019-06-18
dc.date.submittedMay 2019
dc.date.updated2019-07-01T18:31:35Z
dc.description.abstractThis dissertation advances statistical methodology en route to providing new solutions to major questions in empirical finance. The common theme is the balance between structure and flexibility in these models. I show that structure, while it is potentially statistical bias, improves model performance when wisely chosen. Specifically, I look at asset returns' behavior: their relationship with firm characteristics, how they change over time, and what elements may cause their behavior. First, I investigate the forecasting of multiple risk premia. Using the content of Fisher et al. (2019a), I introduce a simulation-free method to model and forecast multiple asset returns and employ it to investigate the optimal ensemble of features to include when jointly predicting monthly stock and bond excess returns. This approach builds on the Bayesian Dynamic Linear Models of West and Harrison (1997), and it can objectively determine, through a fully automated procedure, both the optimal set of regressors to include in the predictive system and the degree to which the model coefficients, volatilities, and covariances should vary over time. When applied to a portfolio of five stock and bond returns, I find that my method leads to large forecast gains, both in statistical and economic terms. In particular, I find that relative to a standard no-predictability benchmark, the optimal combination of predictors, stochastic volatility, and time-varying covariances increases the annualized certainty equivalent returns of a leverage-constrained power utility investor by more than 500 basis points. Here, linear structure is chosen, and then I analyze what parameters should be flexible over time. Second, I consider the problem of determining which characteristics of a firm impact its stock returns. Using the content of Fisher et al. (2019b), I first model a firm's expected return as a nonlinear, nonparametric function of its observable characteristics. I investigate whether theoretically-motivated monotonicity constraints on characteristics and nonstationarity of the conditional expectation function provide statistical and economic benefit. Then, using this model, I provide an approach for characteristic selection using utility functions to summarize the posterior distribution. Standard unexplained volume, short-term reversal, size, and variants of momentum are found to be significant characteristics, and there is evidence that this set changes in time. The data also provide strong support for monotonicity in some of the characteristics' relationships with returns. Hence, the flexibility of the nonlinear, nonparametric curves are regulated by monotonic constraints. Finally, I turn to causal inference to ask which of these characteristics have causal relationships with asset returns. Hahn et al. (2018b) allow for regularized estimation of heterogeneous effects, and I modify their work to allow for non-binary, continuous treatments. This method is highly flexible at fitting complicated response surfaces with discontinuities, interactions, and nonlinearities, and thus benefits from added structure in the form of regularization from shrinkage priors. I demonstrate the model's ability to show the effect of firm size on returns, while controlling for book-to-market.
dc.description.departmentInformation, Risk, and Operations Management (IROM)
dc.format.mimetypeapplication/pdf
dc.identifier.urihttps://hdl.handle.net/2152/75030
dc.identifier.urihttp://dx.doi.org/10.26153/tsw/2138
dc.language.isoen
dc.subjectDynamic linear models
dc.subjectAsset allocation
dc.subjectCross section of returns
dc.subjectPosterior summarization
dc.subjectBayesian econometrics
dc.titleBalancing model structure and flexibility in forecasting financial time series
dc.typeThesis
dc.type.materialtext
thesis.degree.departmentInformation, Risk, and Operations Management (IROM)
thesis.degree.disciplineInformation, Risk, and Operations Management
thesis.degree.grantorThe University of Texas at Austin
thesis.degree.levelDoctoral
thesis.degree.nameDoctor of Philosophy

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