Predicting the equity risk premium using the smooth cross-sectional tail risk: The importance of correlation

Jose Faias

Journal of Financial Markets, 2023, vol. 63, issue C

Abstract: I provide a new monthly cross-sectional measure of stock market tail risk, SCSTR, defined as the average of the daily cross-sectional tail risk, rather than the tail risk of the pooled daily returns within a month. Through simulations, I find that SCSTR better captures monthly tail risk rather than merely the tail risk on specific days within a month. In an extended period from 1964 until 2018, this difference is important in generating strong in- and out-of-sample predictability and performs better than the historical risk premium and other commonly-used predictors for short- and long-term horizons.

Keywords: Equity premium; Prediction; Cross-sectional (search for similar items in EconPapers)
JEL-codes: G11 G14 G17 (search for similar items in EconPapers)
Date: 2023
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Persistent link: https://EconPapers.repec.org/RePEc:eee:finmar:v:63:y:2023:i:c:s1386418122000593

DOI: 10.1016/j.finmar.2022.100769

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