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Equity Premium Prediction: The Role of Economic and Statistical Constraints

Listed author(s):
  • Jiahan Li

    ()

    (University of Notre Dame, USA)

  • Ilias Tsiakas

    ()

    (Department of Economics and Finance, University of Guelph, Canada; The Rimini Centre for Economic Analysis, Italy)

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.

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Paper provided by The Rimini Centre for Economic Analysis in its series Working Paper Series with number 16-25.

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Date of creation: Sep 2016
Handle: RePEc:rim:rimwps:16-25
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