New Forecasts of the Equity Premium
56 Pages Posted: 10 Jan 2005
There are 2 versions of this paper
New Forecasts of the Equity Premium
New Forecasts of the Equity Premium
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: Suggested Citation
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