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Forecasting the Equity Risk Premium: The Role of Technical
Indicators

35 Pages Posted: 21 Mar 2011 Last revised: 10 Mar 2014

Christopher J. Neely

Federal Reserve Bank of St. Louis - Research Division

David Rapach

Saint Louis University - John Cook School of Business

Jun Tu

Singapore Management University - Lee Kong Chian School of Business

Guofu Zhou

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

Date Written: April 11, 2011

Abstract

Academic research has extensively used macroeconomic variables to forecast the U.S. equity risk premium, with 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. In line 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 macroeconomic variables and technical indicators.

Keywords: Equity Risk Premium Predictability, Macroeconomic Variables, Moving-Average Rules, Momentum, Volume, Out-of-Sample Forecasts, Asset Allocation

JEL Classification: C22, C53, 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 (April 11, 2011). Available at SSRN: https://ssrn.com/abstract=1787554 or http://dx.doi.org/10.2139/ssrn.1787554

Christopher J. Neely

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 - John Cook School of Business ( email )

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

Jun Tu

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

50 Stamford Road
#04-01
Singapore, 178899
Singapore

Guofu Zhou (Contact Author)

CAFR (China Academy for Financial Research)

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

Washington University in St. Louis - Olin School of Business ( 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/

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