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http://ssrn.com/abstract=770953
 
 

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Predicting the Equity Premium Out of Sample: Can Anything Beat the Historical Average?


John Y. Campbell


Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Samuel Brodsky Thompson


Arrowstreet Capital, L.P.

July 2005

Harvard Institute of Economic Research Discussion Paper No. 2084

Abstract:     
A number of variables are correlated with subsequent returns on the aggregate US stock market in the 20th Century. Some of these variables are stock market valuation ratios, others reflect patterns in corporate finance or the levels of short and long-term interest rates. Amit Goyal and Ivo Welch (2004) have argued that in-sample correlations conceal a systematic failure of these variables out of sample: None are able to beat a simple forecast based on the historical average stock return. In this note we show that forecasting variables with significant forecasting power in-sample generally have a better out-of-sample performance than a forecast based on the historical average return, once sensible restrictions are imposed on the signs of coefficients and return forecasts. The out-of-sample predictive power is small, but we find that it is economically meaningful. We also show that a variable is quite likely to have poor out-of-sample performance for an extended period of time even when the variable genuinely predicts returns with a stable coefficient.

Number of Pages in PDF File: 30

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Date posted: July 28, 2005  

Suggested Citation

Campbell, John Y. and Thompson, Samuel Brodsky, Predicting the Equity Premium Out of Sample: Can Anything Beat the Historical Average? (July 2005). Harvard Institute of Economic Research Discussion Paper No. 2084. Available at SSRN: http://ssrn.com/abstract=770953 or http://dx.doi.org/10.2139/ssrn.770953

Contact Information

John Y. Campbell (Contact Author)
Harvard University - Department of Economics ( email )
Littauer Center
Room 213
Cambridge, MA 02138
United States
617-496-6448 (Phone)
617-495-7730 (Fax)
HOME PAGE: http://scholar.harvard.edu/campbell
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Samuel Brodsky Thompson
Arrowstreet Capital, L.P. ( email )
44 Brattle St., 5th Floor
Cambridge, MA 02138
United States
617 349 2254 (Phone)
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