Cross-Sectional Return Dispersion and the Equity Premium

42 Pages Posted: 14 Mar 2012 Last revised: 7 Sep 2015

Paulo F. Maio

Hanken School of Economics - Department of Finance and Statistics

Multiple version iconThere are 2 versions of this paper

Date Written: August 27, 2015

Abstract

In this paper, I examine whether stock return dispersion (RD) provides useful information about future stock returns. RD consistently forecasts a decline in the excess market return at multiple horizons, and compares favorably with alternative predictors used in the literature. The out-of-sample performance of RD tends to beat the alternative predictors, and is economically significant as indicated by the certainty equivalent gain associated with a trading investment strategy. RD has greater forecasting power for big and growth stocks compared to small and value stocks, respectively. I discuss a theoretical mechanism giving rise to the negative correlation between RD and the equity premium.

Keywords: asset pricing, stock return dispersion, cross-sectional variance of stock returns, predictability of stock returns, out-of-sample predictability

JEL Classification: G12, G14, G17

Suggested Citation

Maio, Paulo F., Cross-Sectional Return Dispersion and the Equity Premium (August 27, 2015). Journal of Financial Markets, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2021346 or http://dx.doi.org/10.2139/ssrn.2021346

Paulo F. Maio (Contact Author)

Hanken School of Economics - Department of Finance and Statistics ( email )

FI-00101 Helsinki
Finland

HOME PAGE: http://sites.google.com/site/paulofmaio/home

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