New Forecasts of the Equity Premium

Christopher Polk, Samuel Thompson and Tuomo Vuolteenaho

No 10406, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: If investors are myopic mean-variance optimizers, a stock's expected return is linearly related to its beta in the cross section. The slope of the relation is the cross-sectional price of risk, which should equal the expected equity premium. We use this simple observation to forecast the equity-premium time series with the cross-sectional price of risk. We also introduce novel statistical methods for testing stock-return predictability based on endogenous variables whose shocks are potentially correlated with return shocks. Our empirical tests show that the cross-sectional price of risk (1) is strongly correlated with the market's yield measures and (2) predicts equity-premium realizations especially in the first half of our 1927-2002 sample.

JEL-codes: G12 G14 (search for similar items in EconPapers)
Date: 2004-04
New Economics Papers: this item is included in nep-fin and nep-fmk
Note: AP
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Citations: View citations in EconPapers (6)

Published as Polk, Christopher, Samuel Thompson and Tuojmo Vuolteenaho. "Cross-Sectional Forecasts Of The Equity Premium," Journal of Financial Economics, 2006, v81(1,Jul), 101-147.

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