Fundamental Index Aligned and Excess Market Return Predictability : WestminsterResearch

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Title	Fundamental Index Aligned and Excess Market Return Predictability
Type	Journal article
Authors	Ze-To, S.
Abstract	We document the significant predictive power of an aligned fundamental index for aggregate excess stock market returns. The index incorporates the major financial indicators used by Piotroski (2000) and eliminates the idiosyncratic error components of individual indicators using the partial least squares approach modified by Kelly and Pruitt (2015). Our proposed fundamental index outperforms the aggregate financial score index of Piotroski (2000) and the equally weighted financial index in predicting returns for both in-sample and out-of-sample tests. The aligned financial index also provides significant forecasting power for future market returns after controlling for the major economic variables. The proposed index persistently exhibits strong return forecasting power for longer time horizons and generates higher certainty equivalent gain for risk-averse investors. The positive relations between the proposed index and future returns of portfolios sorted by momentum, book-to-market ratio, and company size are all significant.
Keywords	equity risk premium
	fundamental analysis
	partial least squares method
Journal	Journal of Forecasting
Journal citation	41 (3), pp. 592-614
ISSN	1099-131X
Year	2022
Publisher	Wiley
Digital Object Identifier (DOI)	https://doi.org/10.1002/for.2829
Published online	21 Aug 2021
Published in print	Apr 2022

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Fundamental Index Aligned and Excess Market Return Predictability

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