Macro variables and international stock return predictability

In this paper, we examine the predictability of stock returns using macroeconomic variables in 12 industrialized countries. We consider both in-sample and out-of-sample tests of predictive ability, with the out-of-sample forecast period covering the 1990s for each country. We employ recently developed out-of-sample tests that have increased power, namely, the McCracken [Asymptotics for out-of-sample tests of Granger Causality, Manuscript, University of Missouri-Columbia (2004)] variant of the Diebold and Mariano [Journal of Economics Business Statistics 13 (1995) 253] and West [Econometrica 64 (1996) 1067] test for equal predictive ability and the Clark and McCracken [Journal of Econometrics 105 (2001) 85] variant of the Harvey, Leybourne, and Newbold [Journal of Business and Economics Statistics 16 (1998) 254] test for forecast encompassing. In addition to analyzing the predictive ability of each macro variable in turn, we use a procedure that combines general-to-specific model selection with out-of-sample tests of forecasting ability in an effort to identify and test the “best” forecasting model of stock returns in each country. Among the macro variables we consider, interest rates are the most consistent and reliable predictors of stock returns across countries.