NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

New Forecasts of the Equity Premium

Christopher Polk, Samuel Thompson, Tuomo Vuolteenaho

NBER Working Paper No. 10406
Issued in April 2004
NBER Program(s):   AP

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.

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Document Object Identifier (DOI): 10.3386/w10406

Published: Polk, Christopher, Samuel Thompson and Tuojmo Vuolteenaho. "Cross-Sectional Forecasts Of The Equity Premium," Journal of Financial Economics, 2006, v81(1,Jul), 101-147.

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