Beta Optimization

December 6, 2018


In this paper, we test five indices to forecast the one-month ahead performance of the S&P 500 Index. These indices reflect investor sentiment, current business conditions, economic policy uncertainty, and market dislocation information. Each model is used in a logistic analysis to forecast the one-month ahead market direction. Beta optimization refers to a strategy designed to create a portfolio beta of 1.0 when the market is in a bull markets, and a beta of -1.0 when a bear market is expected. Successful application of this strategy generates returns that are consistent with a call option or an option straddle position; that is, positive returns are generated in both up and down markets. Analysis reveals that the models' forecasts have discriminatory power in identifying substantial market movements, particularly during the bursting of the tech bubble (2000-03) and the financial crisis (2008-09).


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