How to Dominate the Historical Average

Kai Li, Yingying Li, Changlei Lyu and Jialin Yu

The Review of Financial Studies, 2025, vol. 38, issue 10, 3086-3116

Abstract: We present a novel methodology for the out-of-sample forecast of the equity premium. Our predictive slope coefficient is a conservative constant that has a lower bias than the zero slope employed by the historical average, but has the same variance. We demonstrate that, theoretically and empirically, our method dominates the historical average in forecast performance. Our methodology establishes a simple yet powerful paradigm for exploiting the real-time equity premium predictability derived from a predictor. Applications of our method reveal that many predictors can forecast the equity premium, and that parameter estimates in previous studies add value to out-of-sample forecasts.

Date: 2025
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