Cross-sectional forecasts of the equity premium

By Christopher Polk, S. B. Thompson, Tuomo Vuolteenaho. 2006

228 citations recorded by the source corpus.

Abstract 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.

Subfields: Economics and Econometrics, Finance, Management Science and Operations Research

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Citations in the corpus

Sufficient Forecasting Using Factor Models (2015, neutral): “Prominent examples include asset return predictability, where we could use the cross section of book-to-market ratios to forecast aggregate market returns (Campbell and Shiller, 1988; Polk et al., 2006; Kelly and Pruitt, 2013).”
Predicting Excess Stock Returns Out of Sample: Can Anything Beat the Historical Average? (2008, methodology): “…for correcting the bias and conducting valid inference [Cavanagh, Elliott, and Stock (1995), Mark (1995), Kilian (1999), Lewellen (2004), Torous, Valkanov, and Yan (2004), Campbell and Yogo (2006), Jansson and Moreira (2006), Polk, Thompson, and Vuolteenaho (2006), and Ang and Bekaert (2007)].”
The Stock Market and Corporate Investment: A Test of Catering Theory (2009, methodology): “We have confirmed that there is no size distortion in our hypothesis tests using the conditional-critical-value function of Polk, Thompson, and Vuolteenaho (2006) .”
Betting Against Beta (2010, unknown): “…While we consider a variety of BAB factors within a number of markets, one notable example is the zero-covariance portfolio introduced by Black (1972) and studied for U.S. stocks by Black, Jensen, and Scholes (1972), Kandel (1984), Shanken (1985), Polk, Thompson, and Vuolteenaho (2006), and others.”
A Comprehensive Look at Financial Volatility Prediction by Economic Variables (2011, unknown): “…explanatory variables are: Dividend price ratio* (DP), book to market ratio* (BM), net equity expansion* (NTIS), cross-sectional premium* (CROPR) of Polk, Thompson, and Vuolteenaho (2006), the Pastor and Stambaugh (2003) liquidity factor (LIQ), return on the MSCI World index (MSCI), US market…”
The Baltic Dry Index as a Predictor of Global Stock Returns, Commodity Returns, and Global Economic Activity (2010, background): “Besides, Baker and Wurgler (2000) explore the role of corporate variables, Polk, Thompson, and Vuolteenaho (2006) examine relative valuations in predicting returns, Hong, Torous, and Valkanov (2007) employ industry portfolio returns, and Bakshi, Panayotov, and Skoulakis (2010) investigate the…”
Predicting market returns using aggregate implied cost of capital (2013, unknown): “This Stock (1995), Stambaugh (1999), Torous, Valkanov, and Yan (2004), Campbell and Yogo (2006), Polk, Thompson, and Vuolteenaho (2006), Ang and Bekaert (2007), and Boudoukh, Richardson, and Whitelaw (2008).”
Predictive Regressions with Time-Varying Coefficients (2012, unknown): “Cross-sectional premium: Cross-Sectional Beta Premium (csp) quantifies the relative valuation of high- and low-beta stocks according to Polk, Thompson, and Vuolteenaho (2006) .9”
Testing predictive regression models with nonstationary regressors (2014, unknown): “…Stambaugh (1986, 1999), Elliott and Stock (1994), Cavanagh et al. (1995), Viceira (1997), Amihud and Hurvich (2004), Torous et al. (2004), Lewellen (2004), Paye and Timmermann (2006), Campbell and Yogo (2006), Polk et al. (2006), Dangl and Halling (2012), Rossi (2007), and the references therein.”
A Comprehensive Look at the Empirical Performance ofEquity Premium Prediction II (2008, unknown): “Developed by Polk, Thompson, and Vuolteenaho (2006), it is the premium of high-beta over low-beta stocks.”