Equity premium prediction: The role of economic and statistical constraints

Jiahan Li and Ilias Tsiakas

Journal of Financial Markets, 2017, vol. 36, issue C, 56-75

Abstract: In this paper, we show that the equity premium is predictable out-of-sample when we use a predictive regression that conditions on a large set of economic fundamentals, subject to: (1) economic constraints on the sign of coefficients and return forecasts, and (2) statistical constraints imposed by shrinkage estimation. Equity premium predictability delivers a certainty equivalent return of about 2.7% per year over the benchmark for a mean–variance investor. Our predictive framework outperforms a large group of competing models that also condition on economic fundamentals, as well as models that condition on technical indicators.

Keywords: Equity premium; Out-of-sample prediction; Economic fundamentals; Technical indicators; Shrinkage estimation (search for similar items in EconPapers)
JEL-codes: G11 G14 G17 (search for similar items in EconPapers)
Date: 2017
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Citations: View citations in EconPapers (50)

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Working Paper: Equity Premium Prediction: The Role of Economic and Statistical Constraints (2016)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:finmar:v:36:y:2017:i:c:p:56-75

DOI: 10.1016/j.finmar.2016.09.001

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