New Forecasts of the Equity Premium

56 Pages Posted: 10 Jan 2005  

Christopher Polk

London School of Economics

Samuel Brodsky Thompson

Arrowstreet Capital, L.P.

Tuomo Vuolteenaho

Arrowstreet Capital, LP; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: March 17, 2004

Abstract

If investors are myopic mean-variance optimizers, a stock's expected return is linearly related to its beta in the cross section. The slope of the relation is the cross-sectional price of risk, which should equal the expected equity premium. We use this simple observation to forecast the equity-premium time series with the cross-sectional price of risk. We also introduce novel statistical methods for testing stock-return predictability based on endogenous variables whose shocks are potentially correlated with return shocks. Our empirical tests show that the cross-sectional price of risk (1) is strongly correlated with the market's yield measures and (2) predicts equity-premium realizations especially in the first half of our 1927-2002 sample.

Keywords: risk premium, beta, bias, size, conditional test

Keywords: risk premium, beta, bias, size, conditional test

JEL Classification: C12, G12, G14

Suggested Citation

Polk, Christopher and Thompson, Samuel Brodsky and Vuolteenaho, Tuomo, New Forecasts of the Equity Premium (March 17, 2004). AFA 2005 Philadelphia Meetings. Available at SSRN: https://ssrn.com/abstract=422901 or http://dx.doi.org/10.2139/ssrn.422901

Christopher Polk

London School of Economics ( email )

United Kingdom

HOME PAGE: http://personal.lse.ac.uk/polk/

Samuel Brodsky Thompson

Arrowstreet Capital, L.P. ( email )

44 Brattle St., 5th Floor
Cambridge, MA 02138
United States
617 349 2254 (Phone)

Tuomo Vuolteenaho (Contact Author)

Arrowstreet Capital, LP ( email )

44 Brattle St., 5th Floor
Cambridge, MA 02138
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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