Two Out-of-Sample Forecasting Models of the Equity Premium

Discussion Papers on Business and Economics, University of Southern Denmark, 11/2020

21 Pages Posted: 12 Jan 2021

See all articles by Thiago de Oliveira Souza

Thiago de Oliveira Souza

affiliation not provided to SSRN; University of Southern Denmark

Multiple version iconThere are 2 versions of this paper

Date Written: November 6, 2020

Abstract

I derive two valid forecasting models of the equity premium in monthly frequency, based on little more than no-arbitrage: A “predictability timing” version of partial least squares, given that predictability is theoretically time varying; and a least squares model with realized market premiums in monthly frequency as the regressor, since realized returns are theoretically correlated to risk and to the price of risk. This evidence is consistent with the instability inherent to monthly equity premium forecasts based on standard partial least squares and disaggregated book-to-markets as regressors, and with the fact that taking one extra lag of book-to-markets in predictive return regressions improves the estimates.

Keywords: predictability, out-of-sample, equity premium, disaggregated book-to-markets

JEL Classification: G11, G12, G14

Suggested Citation

de Oliveira Souza, Thiago and de Oliveira Souza, Thiago, Two Out-of-Sample Forecasting Models of the Equity Premium (November 6, 2020). Discussion Papers on Business and Economics, University of Southern Denmark, 11/2020, Available at SSRN: https://ssrn.com/abstract=3726076 or http://dx.doi.org/10.2139/ssrn.3726076

Thiago De Oliveira Souza (Contact Author)

University of Southern Denmark ( email )

Campusvej 55
DK-5230 Odense, 5000
Denmark

affiliation not provided to SSRN

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