Market Expectations in the Cross‐Section of Present Values
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...Statistically, the partial least squares (PLS) method pioneered by Wold (1966, 1975) and extended by Kelly and Pruitt (2013, 2014) does exactly this job....
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...Following Goyal and Welch (2008), Kelly and Pruitt (2013), and many others, we run the out-of-sample analysis by estimating the predictive regression model recursively based on different measures of investor sentiment, R̂mt+1 = α̂t + β̂tS k 1:t;t (16) where α̂t and β̂t are the OLS estimates from…...
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...To overcome this econometric difficulty, following Wold (1966, 1975), and especially Kelly and Pruitt (2013, 2014), we apply the partial least squares (PLS) approach to extract St effectively and filter out the irrelevant component Et , while the PC method cannot be guaranteed to do so....
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...In this paper, we propose a new investor sentiment index aligned for predicting the aggregate stock market, based on the widely used Baker and Wurgler’s (2006) 6 proxies and by using the PLS method recently introduced to the finance literature by Kelly and Pruitt (2013)....
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...The results are consistent with our early econometric objective of enhancing the forecasting power by eliminating the common noise component of the proxies, which is made possible with the PLS developed further by Kelly and Pruitt (2013, 2014)....
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