Equity Premium Prediction: The Role of Economic and Statistical Constraints

32 Pages Posted: 17 Sep 2014 Last revised: 23 Jul 2016

See all articles by Jiahan Li

Jiahan Li

University of Notre Dame

Ilias Tsiakas

University of Guelph

Date Written: July 22, 2016

Abstract

This paper shows 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: (i) economic constraints on the sign of coefficients and return forecasts, and (ii) 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.

JEL Classification: G11, G14, G17

Suggested Citation

Li, Jiahan and Tsiakas, Ilias, Equity Premium Prediction: The Role of Economic and Statistical Constraints (July 22, 2016). Available at SSRN: https://ssrn.com/abstract=2497060 or http://dx.doi.org/10.2139/ssrn.2497060

Jiahan Li

University of Notre Dame ( email )

156 Hurley Hall
Notre Dame, IN 46556-5646
United States

Ilias Tsiakas (Contact Author)

University of Guelph ( email )

Department of Economics and Finance
University of Guelph
Guelph, Ontario N1G 2W1
Canada
5198244120 ext 53054 (Phone)
5197638497 (Fax)

HOME PAGE: http://www.uoguelph.ca/~itsiakas

Do you want regular updates from SSRN on Twitter?

Paper statistics

Downloads
208
Abstract Views
1,398
rank
199,685
PlumX Metrics