Cross-sectional forecasts of the equity premium

Authors / Editors

Research Areas

Publication Details

Output type: Journal article

Author list: Polk C, Thompson S, Vuolteenaho T

Publisher: Elsevier

Publication year: 2006

Journal: Journal of Financial Economics (0304-405X)

Volume number: 81

Issue number: 1

Start page: 101

End page: 141

Number of pages: 41

ISSN: 0304-405X

eISSN: 1879-2774

Languages: English-Great Britain (EN-GB)

Unpaywall Data

Open access status: green

Full text URL: http://www.globalriskguard.com/resources/assetman/cspremium20040413.pdf

Abstract

If investors are myopic mean-variance optimizers, a stock's expected return is linearly related to its beta in the cross-section. The slope of the relation is the cross-sectional price of risk, which should equal the expected equity premium. We use this simple observation to forecast the equity-premium time series with the cross-sectional price of risk. We also introduce novel statistical methods for testing stock-return predictability based on endogenous variables whose shocks are potentially correlated with return shocks. Our empirical tests show that the cross-sectional price of risk (1) is strongly correlated with the market's yield measures and (2) predicts equity-premium realizations, especially in the first half of our 1927-2002 sample. (c) 2005 Published by Elsevier B.V.

Keywords

CAPM, conditional inference, equity premium, neural networks, predicting returns

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