Option-Implied Equity Premium Predictions via Entropic TiltinG

Davide Pettenuzzo (), Konstantinos Metaxoglou () and Aaron Smith ()
Additional contact information
Konstantinos Metaxoglou: Carleton University
Aaron Smith: University of California, Davis

No 99, Working Papers from Brandeis University, Department of Economics and International Business School

Abstract: We propose a new method to improve density forecasts of the equity premium us- ing information from options markets. We tilt the predictive densities from standard econometric models suggested in the stock return predictability literature towards the second moment of the risk-neutral distribution implied by options prices. In so do- ing, we use a simple regression-based approach to remove the variance risk premium. By combining the backward-looking information contained in the econometric models with the forward-looking information from the options prices, tilting yields sharper predictive densities. Using density forecasts of the U.S. equity premium in Rapach and Zhou (2012), we nd that tilting leads to more accurate predictions, both in terms of statistical and economic performance.

JEL-codes: C11 C22 G11 G12 (search for similar items in EconPapers)
Pages: 34 pages
Date: 2016-01
New Economics Papers: this item is included in nep-for and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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http://www.brandeis.edu/economics/RePEc/brd/doc/Brandeis_WP99.pdf (application/pdf)

Related works:
Journal Article: Option-Implied Equity Premium Predictions via Entropic Tilting (2019)
Working Paper: Option-Implied Equity Premium Predictions via Entropic TiltinG (2016)
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Persistent link: https://EconPapers.repec.org/RePEc:brd:wpaper:99

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