Predictive Regressions Based on Ex Ante Index Futures Market Information

Abstract

The index futures market allows for accurate measure of expected dividends from the aggregate stock market. This paper uses the dividend information exclusively extracted from the S&P 500 futures market to construct the implied dividend yield, implied capital gains and novel measures of cash flow characteristics such as equity duration and convexity as improved predictors for excess market returns. For the period from April 1982 to December 2008, the implied dividend yield, equity duration and convexity have substantial predictive power for equity premium, both in-sample and out-of-sample, over both short- and long-horizon. The implied dividend yield outperforms the historical dividend yield which has severe limitations in forecasting returns. The equity duration and convexity negatively predict the excess returns, which is in line with the findings of a downward sloping term structure of equity premium documented in Binsbergen, Brandt and Koijen (2012). Given the insight that implied dividend yield and implied duration are actually the two different versions of the same type of measure, this paper highlights the important role of cash flow characteristics in the determination of time-varying expected returns.

Keywords: return predictability, index futures

JEL Classification: G11, G12, G14, E44