Bridge over ocean
17 June 2022 Financial Analysts Journal Volume 78, Issue 3

Forecasting the Long-Term Equity Premium for Asset Allocation

Nikolaos Tessaromatis and Athanasios Sakkas

Long-term country equity premium forecasts based on a cross-sectional global factor model (CS-GFM) are superior to forecasts based on other widely used models. CS-GFM forecasts also produce significant utility gains for asset allocation.

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Overview

Long-term country equity premium forecasts based on a cross-sectional global factor model (CS-GFM), where factors represent compensation for risks proxied by valuation and financial variables, are superior, statistically and economically, to forecasts based on time-series prediction models commonly used in academia and practice. CS-GFM equity premium forecasts produce significant utility gains compared to long-term asset allocation strategies based on 18 commonly used prediction models, consistently across the US and 11 developed equity markets.