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Generalized financial ratios to predict the equity premium

(2017) ECONOMIC MODELLING. 66. p.244-257
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Abstract
Empirical evidence for the price-dividend ratio to be a predictor of the equity premium is weak. We argue that changes in the economic conditions and market composition lead to a time-varying relationship between prices, dividends and the equity premium. Exploiting the information in the rolling window log-log regression of stock prices on dividends, we obtain the Generalized Price-Dividend Ratio (GPDR), that compares the price per share with a time-varying transformation of the dividend per share. The GPDR leads to economic and statistical gains when forecasting the equity premium of the S & P 500 at the 1, 3, 6 and 12 month horizon, as compared to using the classical price-dividend ratio or the prevailing historical average excess market return. Similar improvements are obtained for Generalized Financial Ratios based on the corporate earnings and book value.
Keywords
EXPECTED STOCK RETURNS, DIVIDEND-PRICE RATIO, ANYTHING BEAT, RISK, PREMIUM, ALLOCATION, FORECASTS, MARKETS, AVERAGE, Equity premium, ERP, Forecast combination, Price-dividend ratio, Financial ratios, Time-varying parameters

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Chicago
Algaba, Andres, and Kris Boudt. 2017. “Generalized Financial Ratios to Predict the Equity Premium.” Economic Modelling 66: 244–257.
APA
Algaba, A., & Boudt, K. (2017). Generalized financial ratios to predict the equity premium. ECONOMIC MODELLING, 66, 244–257.
Vancouver
1.
Algaba A, Boudt K. Generalized financial ratios to predict the equity premium. ECONOMIC MODELLING. 2017;66:244–57.
MLA
Algaba, Andres, and Kris Boudt. “Generalized Financial Ratios to Predict the Equity Premium.” ECONOMIC MODELLING 66 (2017): 244–257. Print.
@article{8600211,
  abstract     = {Empirical evidence for the price-dividend ratio to be a predictor of the equity premium is weak. We argue that changes in the economic conditions and market composition lead to a time-varying relationship between prices, dividends and the equity premium. Exploiting the information in the rolling window log-log regression of stock prices on dividends, we obtain the Generalized Price-Dividend Ratio (GPDR), that compares the price per share with a time-varying transformation of the dividend per share. The GPDR leads to economic and statistical gains when forecasting the equity premium of the S \& P 500 at the 1, 3, 6 and 12 month horizon, as compared to using the classical price-dividend ratio or the prevailing historical average excess market return. Similar improvements are obtained for Generalized Financial Ratios based on the corporate earnings and book value.},
  author       = {Algaba, Andres and Boudt, Kris},
  issn         = {0264-9993},
  journal      = {ECONOMIC MODELLING},
  language     = {eng},
  pages        = {244--257},
  title        = {Generalized financial ratios to predict the equity premium},
  url          = {http://dx.doi.org/10.1016/j.econmod.2017.07.009},
  volume       = {66},
  year         = {2017},
}

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