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The Role of Current Account Balance in Forecasting the US Equity Premium: Evidence From a Quantile Predictive Regression Approach

Rangan Gupta (), Anandamayee Majumdar () and Mark Wohar ()
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Anandamayee Majumdar: Soochow University

Open Economies Review, 2017, vol. 28, issue 1, 47-59

Abstract: Abstract The purpose of this paper is to investigate whether the current account balance can help in forecasting the quarterly S&P500-based equity premium out-of-sample. We consider an out-of-sample period of 1970:Q3 to 2014:Q4, with a corresponding in-sample period of 1947:Q2 to 1970:Q2. We employ a quantile predictive regression model. The quantile-based approach is more informative relative to any linear model, as it investigates the ability of the current account to forecast the entire conditional distribution of the equity premium, rather than being restricted to just the conditional-mean. In addition, we employ a recursive estimation of both the conditional-mean and quantile predictive regression models over the out-of-sample period which allows for time-varying parameters in the forecast evaluation part of the sample for both of these models. Our results indicate that unlike as suggested by the linear (mean-based) predictive regression model, the quantile regression model shows that the (changes in the) real current account balance contains significant out-of-sample information when the stock market is performing poorly (below the quantile value of 0.3), but not when the market is in normal to bullish modes (quantile value above 0.3). This result seems to be intuitive in the sense that, when the markets are performing average to well, that is performing around the median and above of the conditional distribution of the equity premium, the excess return is inherently a random-walk and hence, no information, from a predictor (changes in the real current account balance) is able to predict the equity premium.

Keywords: Stock markets; Current account; Predictability; Quantile regression; C22; C53; F32; G10 (search for similar items in EconPapers)
Date: 2017
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Working Paper: The Role of Current Account Balance in Forecasting the US Equity Premium: Evidence from a Quantile Predictive Regression Approach (2016)
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