Out-of-Sample Equity Premium Prediction: Combination Forecasts and Links to the Real Economy

62 Pages Posted: 27 Aug 2008 Last revised: 10 Apr 2009

See all articles by David Rapach

David Rapach

Saint Louis University; Washington University in St. Louis

Jack Strauss

University of Denver - Reiman School of Finance; University of Denver

Guofu Zhou

Washington University in St. Louis - John M. Olin Business School; China Academy of Financial Research (CAFR)

Date Written: April 8, 2009

Abstract

While a host of economic variables have been identified in the literature with the apparent in-sample ability to predict the equity premium, Goyal and Welch (2008) find that these variables fail to deliver consistent out-of-sample forecasting gains relative to the historical average. Arguing that substantial model uncertainty and instability seriously impair the forecasting ability of individual predictive regression models, we recommend combining individual model forecasts to improve out-of-sample equity premium prediction. Combining delivers statistically and economically significant out-of-sample gains relative to the historical average on a consistent basis over time. We provide two empirical explanations for the benefits of the forecast combination approach: (i) combining forecasts incorporates information from numerous economic variables while substantially reducing forecast volatility; (ii) combination forecasts of the equity premium are linked to the real economy.

Keywords: portfolio performance between advised and self-directed investors

JEL Classification: C22, C53, G11, G12

Suggested Citation

Rapach, David and Strauss, Jack and Zhou, Guofu, Out-of-Sample Equity Premium Prediction: Combination Forecasts and Links to the Real Economy (April 8, 2009). Available at SSRN: https://ssrn.com/abstract=1257858 or http://dx.doi.org/10.2139/ssrn.1257858

David Rapach

Saint Louis University ( email )

3674 Lindell Blvd
St. Louis, MO 63108-3397
United States

HOME PAGE: http://https://sites.google.com/slu.edu/daverapach

Washington University in St. Louis

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

HOME PAGE: http://https://sites.google.com/slu.edu/daverapach

Jack Strauss

University of Denver - Reiman School of Finance ( email )

2101 S. University Blvd
Denver, CO COLORADO 80126
United States
314 602 7265 (Phone)

University of Denver ( email )

2201 S. Gaylord St
Denver, CO 80208-2685
United States

Guofu Zhou (Contact Author)

Washington University in St. Louis - John M. Olin Business School ( email )

Washington University
Campus Box 1133
St. Louis, MO 63130-4899
United States
314-935-6384 (Phone)
314-658-6359 (Fax)

HOME PAGE: http://apps.olin.wustl.edu/faculty/zhou/

China Academy of Financial Research (CAFR)

Shanghai Advanced Institute of Finance
Shanghai P.R.China, 200030
China

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