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
Date Written: August 3, 2013
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
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