A Comprehensive Look at the Empirical Performance of Equity Premium Prediction

A Comprehensive Look at the Empirical Performance of Equity Premium Prediction
Author(s): Goyal, Amit and Welch, Ivo
Year: 2005
Paper Number: GBS-FIN-2005-001
Goizueta Department: Finance

Abstract

Given the historically high equity premium, is it now a good time to invest in the stock market? Economists have suggested a whole range of variables that investors could or should use to predict: dividend price ratios, dividend yields, earnings-price ratios, dividend payout ratios, net issuing ratios, book-market ratios, interest rates (in various guises), and consumption-based macroeconomic ratios (cay). The typical paper reports that the variable predicted well in an in-sample regression, implying forecasting ability. Our paper explores the out-of-sample performance of these variables, and finds that none would have reliably helped a real-world investor outpredicting the thenprevailing historical equity premium mean. Most would have outright hurt. There are some model candidates worth further investigations, though we deem it too early to put our money on them.