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Forecasting the Equity Risk Premium: The Role of Technical Indicators

Author

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  • Christopher J. Neely

    () (Research Division, Federal Reserve Bank of St. Louis, St. Louis, Missouri 63166)

  • David E. Rapach

    () (Department of Economics, John Cook School of Business, Saint Louis University, St. Louis, Missouri 63108)

  • Jun Tu

    () (Department of Finance, Lee Kong Chian School of Business, Singapore Management University, Singapore 178899)

  • Guofu Zhou

    () (Olin Business School, Washington University in St. Louis, St. Louis, Missouri 63130, CAFR and CUFE)

Abstract

Academic research relies extensively on macroeconomic variables to forecast the U.S. equity risk premium, with relatively little attention paid to the technical indicators widely employed by practitioners. Our paper fills this gap by comparing the predictive ability of technical indicators with that of macroeconomic variables. Technical indicators display statistically and economically significant in-sample and out-of-sample predictive power, matching or exceeding that of macroeconomic variables. Furthermore, technical indicators and macroeconomic variables provide complementary information over the business cycle: technical indicators better detect the typical decline in the equity risk premium near business-cycle peaks, whereas macroeconomic variables more readily pick up the typical rise in the equity risk premium near cyclical troughs. Consistent with this behavior, we show that combining information from both technical indicators and macroeconomic variables significantly improves equity risk premium forecasts versus using either type of information alone. Overall, the substantial countercyclical fluctuations in the equity risk premium appear well captured by the combined information in technical indicators and macroeconomic variables.Data, as supplemental material, are available at http://dx.doi.org/10.1287/mnsc.2013.1838 . This paper was accepted by Wei Jiang, finance.

Suggested Citation

  • Christopher J. Neely & David E. Rapach & Jun Tu & Guofu Zhou, 2014. "Forecasting the Equity Risk Premium: The Role of Technical Indicators," Management Science, INFORMS, vol. 60(7), pages 1772-1791, July.
  • Handle: RePEc:inm:ormnsc:v:60:y:2014:i:7:p:1772-1791
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