Forecasting the Equity Risk Premium: The Role of Technical Indicators

Abstract:     
Academic research has extensively used macroeconomic variables to forecast the U.S. equity risk premium, with little attention paid to the technical indicators widely employed by practitioners. Our paper fills this gap by comparing the forecasting ability of technical indicators with that of macroeconomic variables. Technical indicators display statistically and economically significant in-sample and out-of-sample forecasting power, matching or exceeding that of macroeconomic variables. Furthermore, technical indicators and macroeconomic variables provide complementary information over the business cycle: technical indicators better detect the typical decline in the equity risk premium near business-cycle peaks, while macroeconomic variables more readily pick up the typical rise in the equity risk premium near cyclical troughs. In line with this behavior, we show that combining information from both technical indicators and macroeconomic variables significantly improves equity risk premium forecasts versus using either type of information alone. Overall, the substantial countercyclical fluctuations in the equity risk premium appear well captured by the combined information in macroeconomic variables and technical indicators.

Number of Pages in PDF File: 35

Keywords: Equity Risk Premium Predictability, Macroeconomic Variables, Moving-Average Rules, Momentum, Volume, Out-of-Sample Forecasts, Asset Allocation

JEL Classification: C22, C53, E32, G11, G12, G17

working papers series