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

Abstract

We investigate whether proxies of the expected return on the market prescribed by economic theory can subsume information from agnostic statistical approaches. Our results show that (i) economic restrictions—derived from no-arbitrage conditions or present value identities—deliver significant out-of-sample predictability; (ii) among statistical models, complete subset regressions (CSR) achieve the best performance, comparable to theoretically restricted models; (iii) neither approach subsumes the other, suggesting complementary information; (iv) a simple equal-weight average matches or exceeds either approach individually in both statistical and economic performance.

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• Working Paper

Presentations

FMA Annual Meeting 2023, 4th Frontiers of Factor Investing Conference, 2023 QuantMinds International, 2024 Meeting of the Brazilian Finance Society, FinML 2024 at USI Lugano, 11th IAAE at the University of Turin.

Citation

Bianchi, Daniele, Alexandre Rubesam, and Andrea Tamoni. “It Takes Two to Tango: Economic Theory and Model Uncertainty for Equity Premium Prediction.” Working paper.

@article{bianchi2025takes,
  title={It takes two to tango: Economic theory and model uncertainty for equity premium prediction},
  author={Bianchi, Daniele and Rubesam, Alexandre and Tamoni, Andrea},
  journal={Available at SSRN 4513241},
  year={2025}
}