Out-of-sample equity premium prediction: economic fundamentals vs. moving-average rules

Christopher Neely, David E. Rapach, Jun Tu () and Guofu Zhou

No 2010-008, Working Papers from Federal Reserve Bank of St. Louis

Abstract: This paper analyzes the ability of both economic variables and moving-average rules to forecast the monthly U.S. equity premium using out-of-sample tests for 1960?2008. Both approaches provide statistically and economically significant out-of-sample forecasting gains, which are concentrated in U.S. business-cycle recessions. Nevertheless, economic variables and moving-average rules capture different sources of equity premium fluctuations: moving average rules detect the decline in the average equity premium early in recessions, while economic variables more readily pick up the rise in the average equity premium later in recessions. When we simulate data with a habit-formation model characterized by time-varying return volatility and risk aversion relating to business-cycle fluctuations, we find that this model cannot fully account for the out-of-sample forecasting gains in the actual data evidenced by economic variables and moving-average rules.

Keywords: Forecasting; Stocks (search for similar items in EconPapers)
Date: 2010
New Economics Papers: this item is included in nep-cba, nep-for and nep-upt
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Citations: View citations in EconPapers (21)

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Related works:
Journal Article: Forecasting the Equity Risk Premium: The Role of Technical Indicators (2014)
Working Paper: Forecasting the Equity Risk Premium: The Role of Technical Indicators (2011)
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DOI: 10.20955/wp.2010.008

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