Working Paper: NBER ID: w10483
Authors: Amit Goyal; Ivo Welch
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 not a single one would have helped a real-world investor outpredicting the then-prevailing historical equity premium mean. Most would have outright hurt. Therefore, we find that, for all practical purposes, the equity premium has not been predictable, and any belief about whether the stock market is now too high or too low has to be based on theoretical prior, not on the empirically variables we have explored.
Keywords: equity premium; stock market; predictability; financial variables
JEL Codes: G12; G14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| dividend-price ratios (G35) | equity premium (G12) |
| earnings-price ratios (G12) | equity premium (G12) |
| interest rates (E43) | equity premium (G12) |
| predictive variables (C39) | equity premium (G12) |