Equity Risk Premium Predictability from Cross-Sectoral Downturns

62 Pages Posted: 12 Jun 2015 Last revised: 11 Aug 2019

See all articles by José Afonso Faias

José Afonso Faias

Catholic University of Portugal (UCP)

Juan Arismendi Zambrano

National University of Ireland, Maynooth (NUI Maynooth) - Department of Economics, Finance and Accounting; University of Reading - ICMA Centre

Date Written: July 1, 2019

Abstract

We illustrate the role of left tail dependence measures, left exceedance correlation (LEC) and left tail mean (LTM), in equity risk premium (ERP) predictability. LEC and LTM measure the average of pairwise left tail dependency among major equity sectors incorporating shocks that are imperceptible at the aggregate level. LEC and LTM, as the variance risk premium (VRP), significantly predict the ERP in- and out-of-sample, which is not the case with the other commonly used predictors. We find predictability is the result of pro-cyclical shocks in a stable business cycle. This paper contributes to the ongoing debate on ERP predictability.

Keywords: predictability, left tail dependence, asset pricing model

JEL Classification: G10, G12, G14

Suggested Citation

Faias, José and Arismendi Zambrano, Juan, Equity Risk Premium Predictability from Cross-Sectoral Downturns (July 1, 2019). Available at SSRN: https://ssrn.com/abstract=2617242 or http://dx.doi.org/10.2139/ssrn.2617242

José Faias (Contact Author)

Catholic University of Portugal (UCP) ( email )

Palma de Cima
Lisboa, 1649-023
Portugal

Juan Arismendi Zambrano

National University of Ireland, Maynooth (NUI Maynooth) - Department of Economics, Finance and Accounting ( email )

County Kildare
Ireland
+353 17087267 (Phone)

HOME PAGE: http://https://www.maynoothuniversity.ie/economics-finance-and-accounting/

University of Reading - ICMA Centre ( email )

Whiteknights Park
P.O. Box 242
Reading, RG6 6BA
United Kingdom

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