Predicting the Equity Premium with Combination Forecasts: A Reappraisal

Abstract

This paper reappraises the usefulness of combining individual forecasts for predicting the US equity premium. For comparison, we also consider penalized regression and dimension reduction approaches. We fail to find evidence of predictive ability in recent decades, regardless of the forecasting method used. Further analysis shows that an increase in the correlation of individual forecast errors is an important factor in the declining performance of combination forecasts.

Keywords: Equity premium, return predictability, forecast combination

JEL Classification: C53, G12, G17