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Out-of-Sample Equity Premium Prediction: Combination Forecasts and Links to the Real Economy

Out-of-Sample Equity Premium Prediction: Combination Forecasts and Links to the Real Economy Welch and Goyal (2008) find that numerous economic variables with in-sample predictive ability for the equity premium fail to deliver consistent out-of-sample forecasting gains relative to the historical average. Arguing that model uncertainty and instability seriously impair the forecasting ability of individual predictive regression models, we recommend combining individual forecasts. Combining delivers statistically and economically significant out-of-sample gains relative to the historical average consistently over time. We provide two empirical explanations for the benefits of forecast combination: (i) combining forecasts incorporates information from numerous economic variables while substantially reducing forecast volatility; (ii) combination forecasts are linked to the real economy. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png The Review of Financial Studies Oxford University Press

Out-of-Sample Equity Premium Prediction: Combination Forecasts and Links to the Real Economy

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Publisher
Oxford University Press
Copyright
© The Author 2009. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please email: journals.permissions@oxfordjournals.org
Subject
Article
ISSN
0893-9454
eISSN
1465-7368
DOI
10.1093/rfs/hhp063
Publisher site
See Article on Publisher Site

Abstract

Welch and Goyal (2008) find that numerous economic variables with in-sample predictive ability for the equity premium fail to deliver consistent out-of-sample forecasting gains relative to the historical average. Arguing that model uncertainty and instability seriously impair the forecasting ability of individual predictive regression models, we recommend combining individual forecasts. Combining delivers statistically and economically significant out-of-sample gains relative to the historical average consistently over time. We provide two empirical explanations for the benefits of forecast combination: (i) combining forecasts incorporates information from numerous economic variables while substantially reducing forecast volatility; (ii) combination forecasts are linked to the real economy.

Journal

The Review of Financial StudiesOxford University Press

Published: Feb 11, 2010

Keywords: JEL Classification C22 C53 G11 G12

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