Cointegration for market forecast in the Spanish stock market

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Abstract
This study is interested in empirically testing the existence of a long-run relationship between the Spanish stock market and its fundamentals, and in checking to which extent this relationship helps in forecasting. This study is concerned with the behaviour of the aggregate Madrid Stock Exchange in a macroeconomic context. It also identifies as macroeconomic fundamentals: industrial production as a proxy for real activity, inflation and interest rates. This study tests the existence of cointegration by Johansen's procedure. The long-run relationships among the variables implied by the existence of cointegration do not allow inference to the interrelations among the variables. To get some insight into the short-run interactions among the variables, an impulse response analysis was performed. This study compares the forecasting ability of its model with respect to alternative multivariate specifications in terms of RMSE. Also measured is the value of the forecast for the financial agents assessing the extent to which it helps improve asset allocation.