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Time-frequency forecast of the equity premium

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  • Faria, Gonçalo
  • Verona, Fabio

Abstract

Any time series can be decomposed into cyclical components fluctuating at different frequencies. Accordingly, in this paper we propose a method to forecast the stock market's equity premium which exploits the frequency relationship between the equity premium and several predictor variables. We evaluate a large set of models and find that, by selecting the relevant frequencies for equity premium forecasting, this method significantly improves in both statistical and economic sense upon standard time series forecasting methods. This improvement is robust regardless of the predictor used, the out-of-sample period considered, and the frequency of the data used.

Suggested Citation

  • Faria, Gonçalo & Verona, Fabio, 2020. "Time-frequency forecast of the equity premium," Research Discussion Papers 6/2020, Bank of Finland.
  • Handle: RePEc:bof:bofrdp:2020_006
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    JEL classification:

    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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