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Jurnal

Journal of Financial Economics

Keyword

Economic constraints; Sharpe ratio; Equity premium predictions

Pengarang

  1. Davide Pettenuzzo,
  2. Allan Timmermann,
  3. Rossen Valkanov

    Subject

    Economics

    [Abstrak]

    We propose a new approach to imposing economic constraints on time series forecasts of the equity premium. Economic constraints are used to modify the posterior distribution of the parameters of the predictive return regression in a way that better allows the model to learn from the data. We consider two types of constraints: non-negative equity premia and bounds on the conditional Sharpe ratio, the latter of which incorporates time-varying volatility in the predictive regression framework. Empirically, we find that economic constraints systematically reduce uncertainty about model parameters, reduce the risk of selecting a poor forecasting model, and improve both statistical and economic measures of out-of-sample forecast performance.

    Periode

    Vol 114, Nomor 3, Tahun 2014

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