Forecasting the Equity Risk Premium: The Role of Technical Indicators

Federal Reserve Bank of St. Louis Working Paper No. 2010-008H

48 Pages Posted: 11 Mar 2010 Last revised: 3 Feb 2014

See all articles by Christopher J. Neely

Christopher J. Neely

Federal Reserve Bank of St. Louis - Research Division

David Rapach

Saint Louis University; Washington University in St. Louis

Jun Tu

Singapore Management University - Lee Kong Chian School of Business

Guofu Zhou

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

Date Written: August 3, 2013

Abstract

Academic research relies extensively on macroeconomic variables to forecast the U.S. equity risk premium, with relatively 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. Consistent 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 technical indicators and macroeconomic variables.

Keywords: equity risk premium predictability, macroeconomic variables, moving-average rules, momentum, volume, sentiment, out-of-sample forecasts, asset allocation, business cycle

JEL Classification: C53, C58, E32, G11, G12, G17

Suggested Citation

Neely, Christopher J. and Rapach, David and Tu, Jun and Zhou, Guofu, Forecasting the Equity Risk Premium: The Role of Technical Indicators (August 3, 2013). Federal Reserve Bank of St. Louis Working Paper No. 2010-008H. Available at SSRN: https://ssrn.com/abstract=1568267 or http://dx.doi.org/10.2139/ssrn.1568267

Christopher J. Neely (Contact Author)

Federal Reserve Bank of St. Louis - Research Division ( email )

411 Locust St
Saint Louis, MO 63011
United States
314-444-8568 (Phone)
314-444-8731 (Fax)

HOME PAGE: http://www.stls.frb.org/research/econ/cneely/

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

Jun Tu

Singapore Management University - Lee Kong Chian School of Business ( email )

50 Stamford Road
#04-01
Singapore, 178899
Singapore

Guofu Zhou

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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