Equity premium prediction: keep it sophisticatedly simple

Anwen Yin; Anwen Yin

doi:10.3934/QFE.2021012

Quantitative Finance and Economics

2021, Volume 5, Issue 2: 264-286. doi: 10.3934/QFE.2021012

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Research article

Equity premium prediction: keep it sophisticatedly simple

Anwen Yin ^,

A.R. Sanchez, Jr. School of Business, Texas A & M International University, 5201 University Blvd, Laredo, TX 78041, USA

Received: 01 March 2021 Accepted: 09 April 2021 Published: 14 April 2021
JEL Codes: C53, C58, G11, G17

Following the keep-it-sophisticatedly-simple principle, KISS, we propose using the averaging window approach to forecast the market equity premium in unstable environments. First, the estimation methodology of averaging window is a theoretically justified method robust to uncertainties on structural breaks and estimation window sizes. Second, the averaging window method has the obvious advantages of being understandable to forecast users and simple to implement, thus encouraging engagement and criticism. Our empirical results demonstrate the superior performance of the averaging window when forecasting the U.S. market equity premium, exceeding a wide range of methods which have been shown effective, such as shrinkage estimators and technical indicators.
- equity premium,
- forecast combination,
- structural break,
- averaging window
Citation: Anwen Yin. Equity premium prediction: keep it sophisticatedly simple[J]. Quantitative Finance and Economics, 2021, 5(2): 264-286. doi: 10.3934/QFE.2021012

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Abstract

Following the keep-it-sophisticatedly-simple principle, KISS, we propose using the averaging window approach to forecast the market equity premium in unstable environments. First, the estimation methodology of averaging window is a theoretically justified method robust to uncertainties on structural breaks and estimation window sizes. Second, the averaging window method has the obvious advantages of being understandable to forecast users and simple to implement, thus encouraging engagement and criticism. Our empirical results demonstrate the superior performance of the averaging window when forecasting the U.S. market equity premium, exceeding a wide range of methods which have been shown effective, such as shrinkage estimators and technical indicators.

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