Publisher's Synopsis
Excerpt from On Market Timing and Investment, Performance Part II: Statistical Procedures for Evaluating Forecasting Skills
In Part I, one of usl/ developed a basic model of market timing forecasts where the forecaster predicts when stocks will outperform bonds and when bonds will outperform stocks but he does not predict the magnitude of the superior performance. In that analysis, it was shown that the pattern of returns from successful market timing has an isomorphic correspondence to the pattern of returns from following certain option investment strategies where the implicit prices paid for the options are less than their fair or market values. This isomorphic correspondence was used to derive an equilibrium theory of value for market timing forecasting skills. By analyzing how investors would use the market timer's forecast to modify their probability beliefs about stock returns, it was shown that the conditional probabilities of a correct forecast (conditional on the return on the market) provide both necessary and sufficient conditions for such forecasts to have a positive value.
In the analysis presented here, we use the basic model of market timing derived in Part I to develop both parametric and nonparametric statistical procedures to test for superior forecasting skills.
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