Forecasting banks return on equity using leading economic indicators

Abstract

The research examines an approach to forecast return on equity using leading economic indicators for short periods in banks. ROE is one of the most important ratios for performance measurement. Its adequacy is necessary for competitiveness, attract funding in financial markets, accumulate reserve for future turbulences, secure compliance with supervisory requirements and maintain positive signals for the market. There is still a debate in the literature on factors of commercial banks’ profitability forecasting, techniques, and most appropriate models to improve the correctness of predicting and acquiring more accurate signals for communication on targets. The problems are still relevant from both a theoretical perspective and practical implementation. This research aims to prove the necessity to include leading economic indicators for short term ROE forecasting. It conducts investigations for the relevant studies, using regression analysis, necessary tests, ascertains opportunities and limitations of using these indicators and develops a conceptual model and its assessment major Baltic banks. The results show verification of approach to forecast ROE using leading economic indicators for short periods. Such study complements signalling theory with a new approach, how to predict and acquire signal not only using economic indicators as a general group but sub-group them into coinciding, lagging and leading.