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Market Timing with Aggregate and Idiosyncratic Stock Volatilities | an Overview

Last Updated on 10 February, 2024 by Rejaul Karim

Market Timing with Aggregate and Idiosyncratic Stock Volatilities” is an academic paper authored by Hui Guo and Jason Higbee that builds on their previous work, putting its findings to an empirical test.

The authors investigate the economic implications of forecasting stock returns by aggregating stock market volatility and considering average idiosyncratic stock volatility. They assess the performance of a portfolio manager executing a mean-variance market timing strategy based on these variables.

Spanning over the 1968-2004 period, their research indicates that this market-timing strategy has significant potential to outperform the traditional buy-and-hold strategy, both statistically and economically. This paper thus serves as an important contribution to the discourse on stock return predictability and market timing.

Abstract Of Paper

Guo and Savickas [2005] show that aggregate stock market volatility and average idiosyncratic stock volatility jointly forecast stock returns. In this paper, we quantify the economic significance of their results from the perspective of a portfolio manager. That is, we evaluate the performance, e.g., the Sharpe ratio and Jensen’s alpha, of a mean-variance manager who tries to time the market based on those variables. We find that, over the period 1968-2004, the associated market-timing strategy outperforms the buy-and-hold strategy, and the difference is statistically and economically significant.

Original paper – Download PDF

Here you can download the PDF and original paper of Market Timing with Aggregate and Idiosyncratic Stock Volatilities.

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Author

Hui Guo
University of Cincinnati – Department of Finance – Real Estate

Jason Higbee
Federal Reserve Bank of St. Louis – Research Division

Conclusion

In conclusion, “Market Timing with Aggregate and Idiosyncratic Stock Volatilities” provides compelling evidence in favor of a market-timing strategy over a buy-and-hold strategy in the presence of aggregate market volatility and idiosyncratic stock volatility.

The research quantifies the economic significance of this approach and underscores its potential to yield superior results from a portfolio management standpoint. The authors find that between 1968 and 2004, the proposed market timing strategy notably outperforms the traditional buy-and-hold strategy.

The difference, both statistically and economically significant, hints at a promising vantage point for market timing based on these factors, renewing conversations around stock return predictability and market volatility.

Related Reading:

Moving Average Distance as a Predictor of Equity Returns

Asset Pricing Anomalies and the Low-Risk Puzzle

FAQ

What is the main focus of the research paper “Market Timing with Aggregate and Idiosyncratic Stock Volatilities”?

The main focus of the research paper is to evaluate the economic implications of forecasting stock returns by considering aggregate stock market volatility and average idiosyncratic stock volatility. The authors, building on previous work, assess the performance of a mean-variance portfolio manager executing a market-timing strategy based on these variables. The objective is to compare this strategy with the traditional buy-and-hold approach and quantify the economic significance of the results.

How does the paper contribute to the discourse on stock return predictability and market timing?

The paper contributes to the discourse on stock return predictability and market timing by providing empirical evidence on the effectiveness of a market-timing strategy based on aggregate and idiosyncratic stock volatilities. The authors extend prior research by evaluating the economic significance of their findings from the perspective of a portfolio manager. The research indicates that the proposed market-timing strategy has the potential to outperform the traditional buy-and-hold strategy.

What is the key finding of the paper regarding the market-timing strategy?

The key finding of the paper is that the market-timing strategy, which incorporates aggregate stock market volatility and average idiosyncratic stock volatility, outperforms the buy-and-hold strategy. The outperformance is both statistically and economically significant. Over the period from 1968 to 2004, the market-timing strategy demonstrates notable superiority, suggesting its potential as a valuable approach for portfolio managers.

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