SEMINAR OF THE THEMATIC PROJECT

Seminar of the Thematic Project (2023/01728-0) Econometric Modlling and Forecasting in High Dimensional Models (HDEM&For)

Speaker: Alexandre Rubesam (IESEG, France)

Title: It Takes Two to Tango: Economic Theory and Model Uncertainty for Equity Premium Prediction

Abstract

We assess whether imposing economic restrictions on conventional predictive regressions provides additional insights into the equity premium beyond those obtained from agnostic statistical methods, particularly forecast combination strategies. The results show that combination strategies do not subsume the forecasts from regressions with economically motivated restrictions, and vice versa. This suggests that flexible statistical methods can enhance, rather than dilute, the importance of economic theory for equity premium predictability. However, when considered in isolation, forecasts from neither combination strategies nor economic restrictions are likely to represent the expected return on the market. In other words, it takes two to tango.