Journal of Financial Economics Vol. 81 No. 1 2006
Cross-sectional forecasts of the equity premium☆
Abstract
If investors are myopic mean-variance optimizers, a stock's expected return is linearly related to its beta in the cross-section. The slope of the relation is the cross-sectional price of risk, which should equal the expected equity premium. We use this simple observation to forecast the equity-premium time series with the cross-sectional price of risk. We also introduce novel statistical methods for testing stock-return predictability based on endogenous variables whose shocks are potentially correlated with return shocks. Our empirical tests show that the cross-sectional price of risk (1) is strongly correlated with the market's yield measures and (2) predicts equity-premium realizations, especially in the first half of our 1927–2002 sample.
- DOI
- 10.1016/j.jfineco.2005.03.013
- Volume
- 81
- Issue
- 1
- Pages
- 101-141
- Language
- en
- Sources
- bibtex:phds-export.bib openalex crossref