Predictability of equity premium in South Africa using financial and macroeconomic indicators

Abstract

The equity premium represents the additional rate of return, in excess of the riskfree rate, required by investors for holding equity. The equity premium is one of the most important numbers in modern day finance and economics. Despite its importance, it has been challenging to predict. The purpose of the present study was to assess the predictability of the equity premium in South Africa. The literature review identified numerous factors that impact the equity premium. The relationship between various financial and macroeconomic indicators and the equity premium was assessed. Individually, eight of the fourteen variables tested demonstrated a statistically significant association with the equity premium. Regression models that condition on a large number of independent variables were assessed in terms of their in-sample significance and relative out-of-sample performance. The results found that equity premium is predictable when utilising penalised regressions. The introduction of statistical constraints improved model performance. The significance of the variance explained by the models indicated that they have the potential to be beneficial to stakeholders