Macroeconomic attention and stock market return predictability

Our investigation evaluates the novel macroeconomic attention indices (MAI) of Fisher et al. (2021) in terms of their ability to predict stock market returns based on dimension reduction methods and shrinkage methods. Our results demonstrate that macroeconomic attention indices can predict stock market returns with a significant degree of accuracy. In addition, the components of MAI indices based on partial least squares (PLS) and the least absolute shrinkage and selection operator (LASSO) methods have a greater capacity to improve the accuracy of the prediction of stock market returns than the components of the traditional macroeconomic variables. Moreover, we find that shrinkage methods can generate performances superior to those of the other models for forecasting stock market returns. We further demonstrate that macroeconomic attention indices embody superior predictive ability during the COVID-19 pandemic and over longer periods of time. Our study sheds new light on stock market returns’ prediction from the perspective of macroeconomic fundamentals.