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Equity Premium Prediction: The Role of Economic and Statistical Constraints

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  • 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)

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.

Suggested Citation

  • Jiahan Li & Ilias Tsiakas, 2016. "Equity Premium Prediction: The Role of Economic and Statistical Constraints," Working Paper series 16-25, Rimini Centre for Economic Analysis.
  • Handle: RePEc:rim:rimwps:16-25
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    References listed on IDEAS

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    Cited by:

    1. repec:eee:finana:v:52:y:2017:i:c:p:49-61 is not listed on IDEAS
    2. repec:eee:empfin:v:45:y:2018:i:c:p:141-156 is not listed on IDEAS

    More about this item

    Keywords

    Equity Premium; Out-of-Sample Prediction; Economic Fundamentals; Technical Indicators; Shrinkage Estimation;

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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