Forecasting stock returns with industry volatility concentration

Abstract In this paper, we show that industry volatility concentration is a strong predictor for aggregate stock market returns. Our monthly industry volatility concentration (IVC) index displays significant predictive ability, with in‐sample and out‐of‐sample R 2 statistics of 0.686% and 0.712%, respectively, which outperforms a host of prevailing return predictors. Moreover, the IVC index can generate high utility gains of 143.8 basis points above the historical average benchmark for mean–variance investors. We find that the IVC index is countercyclical. Furthermore, the predictive source of the IVC index not only stems from the cash flow and discount rate channels but is also explained by the channels of investor attention and sentiment. The predictive ability of our IVC index also remains significant under a broad range of robustness tests.