Multivariate models for the prediction of stock returns in an emerging market economy: comparison of parametric and non-parametric models

This paper compares the forecasting performance of three structural econometric models, namely the non-parametric, ARIMAX and the Kalman filter models, in predicting stock returns in an emerging market economy using South Africa as a case study. The proposed models have different functional forms. Each of the functional forms accounts for specific characteristics and properties of stock returns in general and in a small open economy in particular. The findings of the paper indicate that the Kalman filter and ARIMAX model both outperform the non-parametric model indicating the dominant characteristics of nonlinearity and Markov properties of stock market returns in South Africa.