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 variant of the Diebold and Mariano and West test for equal predictive ability and the Clark & McCracken variant of the Harvey et al. 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.