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Can Economic Uncertainty, Financial Stress and Consumer Sentiments Predict U.S. Equity Premium?

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  • Rangan Gupta
  • Shawkat Hammoudeh
  • Mampho P. Modise
  • Duc Khuong Nguyen

Abstract

This article attempts to examine whether the equity premium in the United States can be predicted from a comprehensive set of 18 economic and financial predictors over a monthly out-of-sample period of 2000:2 to 2011:12, using an in-sample period of 1990:2-2000:1. To do so, we consider, in addition to the set of variables used in Rapach and Zhou (2013), the forecasting ability of four other important variables: the US economic policy uncertainty, the equity market uncertainty, the University of Michigan’s index of consumer sentiment, and the Kansas City Fed’s financial stress index. Using a more recent dataset compared to that of Rapach and Zhou (2013), our results from predictive regressions show that the newly added variables do not play any significant statistical role in explaining the equity premium relative to the historical average benchmark over the out-of-sample horizon, even though they are believed to possess valuable informative content about the state of the economy and financial markets. Interestingly, however, barring the economic policy uncertainty index, the three other indexes considered in this study yields economically significant out-of-sample gains, especially during recessions, when compared to the historical benchmark.

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Bibliographic Info

Paper provided by Department of Research, Ipag Business School in its series Working Papers with number 2013-020.

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Length: 24 pages
Date of creation: 01 Sep 2013
Date of revision:
Handle: RePEc:ipg:wpaper:2013-020

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Keywords: Equity premium forecasting; asset pricing model; economic uncertainty; business cycle;

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  1. Rangan Gupta & Mampho P. Modise & Josine Uwilingiye, 2011. "Out-of-Sample Equity Premium Predictability in South Africa: Evidence from a Large Number of Predictors," Working Papers 201122, University of Pretoria, Department of Economics.
  2. Serena Ng & Pierre Perron, 1997. "Lag Length Selection and the Construction of Unit Root Tests with Good Size and Power," Boston College Working Papers in Economics 369, Boston College Department of Economics, revised 01 Sep 2000.
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  9. Amit Goyal & Ivo Welch, 2004. "A Comprehensive Look at the Empirical Performance of Equity Premium Prediction," Yale School of Management Working Papers, Yale School of Management amz2412, Yale School of Management, revised 01 Jan 2006.
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  20. David E. Rapach & Jack K. Strauss & Guofu Zhou, 2010. "Out-of-Sample Equity Premium Prediction: Combination Forecasts and Links to the Real Economy," Review of Financial Studies, Society for Financial Studies, vol. 23(2), pages 821-862, February.
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Citations

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Cited by:
  1. Wendy Nyakabawo & Stephen M. Miller & Mehmet Balcilar & Sonali Das & Rangan Gupta, 2013. "Temporal Causality between House Prices and Output in the U. S.: A Bootstrap Rolling-Window Approach," Working Papers 201329, University of Pretoria, Department of Economics.
  2. Beatrice D. Simo-Kengne & Stephen M. Miller & Rangan Gupta, 2014. "Evolution of Monetary Policy in the US: The Role of Asset Prices," Working Papers 2014-459, Department of Research, Ipag Business School.
  3. Naceur Naguez & Jean-Luc Prigent, 2014. "Kappa Performance Measures with Johnson Distributions," Working Papers 2014-510, Department of Research, Ipag Business School.

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