The change in stock-selection risk and stock market returns

Following Jiang et al. (2021), who propose a stock-selection opportunity (SSO) measurement by the absolute average positive alpha of individual stocks to reflect stock-selection timing, we construct a stock-selection risk (SSR) measure from the perspective of negative alphas of individual stocks. Then, we investigate the predictive abilities of SSO, SSR, the change of SSO (CSSO), and the change of SSR (CSSR) on stock market returns. By using data from 2003 to 2020 in China, we find that only CSSR significantly predicts future one-month market returns. Moreover, considering other popular predictors, our in-sample and out-of-sample results and a series of robustness checks support the proposal that CSSR provides unique information for predicting market returns that reduces forecast errors and increases economic value for investors. Furthermore, our trading activity evidence shows that CSSR predicts stock market returns due to investors' underreaction to the information of CSSR.