Is the Ex-Ante Equity Risk Premium Always Positive? Evidence from a Statistical Learning Method

43 Pages Posted: 14 Feb 2015 Last revised: 10 Apr 2019

See all articles by Khoa T.A. Hoang

Khoa T.A. Hoang

University of Queensland - Business School

Robert W. Faff

University of Queensland

Date Written: February 13, 2015

Abstract

In this paper, we propose a new two-stage method, including Principal Component Analysis and Boosted Regression Tree, to model conditional expected returns. With this technique, we address two potential criticisms on how to capture the true identity of the investors’ information set, and how investors use the information in forming expected returns. Applying this risk premium proxy, we test whether risk premium is always positive. A number of asset pricing studies have focused on testing linear restrictions imposed by asset pricing models and largely ignore this important restriction. We find evidence that the positivity condition of the risk premium is violated for the US (CRSP index) in some states of the economy; these states are associated with periods of low corporate returns, low long term government bond returns, lagged negative risk premium, and downward sloping term structure.

Keywords: Ex-ante risk premium, conditional asset pricing, boosted regression tree, principal component analysis, multiple conditional inequality constraints

JEL Classification: G12; C22

Suggested Citation

Hoang, Khoa T.A. and Faff, Robert W., Is the Ex-Ante Equity Risk Premium Always Positive? Evidence from a Statistical Learning Method (February 13, 2015). Available at SSRN: https://ssrn.com/abstract=2564348 or http://dx.doi.org/10.2139/ssrn.2564348

Khoa T.A. Hoang (Contact Author)

University of Queensland - Business School ( email )

Brisbane, Queensland 4072
Australia

Robert W. Faff

University of Queensland ( email )

St Lucia
Brisbane, Queensland 4072
Australia

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