that I am going to take for a spin over breakfast in the AM (HT: reader KJ)
“Out of Sample Equity Premium Prediction: Economic Fundamentals vs. Moving Average Rules”
Abstract
This paper analyzes the ability of both economic variables and moving-average rules to
forecast the monthly U.S. equity premium using out-of-sample tests for 1960–2008. Both
approaches provide statistically and economically significant out-of-sample forecasting gains,
which are concentrated in U.S. business-cycle recessions. Nevertheless, economic variables
and moving-average rules capture different sources of equity premium fluctuations: moving average
rules detect the decline in the average equity premium early in recessions, while economic
variables more readily pick up the rise in the average equity premium later in recessions.
When we simulate data with a habit-formation model characterized by time-varying return
volatility and risk aversion relating to business-cycle fluctuations, we find that this model
cannot fully account for the out-of-sample forecasting gains in the actual data evidenced by
economic variables and moving-average rules.
