arXiv 23 Dec 2025 · Finance — Statistical Finance
arXiv:2512.20460 · PDF · DOI · OpenAlex · Extracted main text
A growing empirical literature suggests that equity-premium predictability is state dependent, with much of the forecasting power concentrated around recessionary periods (Henkel et al., 2011; Dangl and Halling, 2012; Devpura et al., 2018). I study U.S. stock return predictability across economic regimes and document strong evidence of time-varying expected returns across both expansionary and contractionary states. I contribute in two ways. First, I introduce a state-switching predictive regression in which the market state is defined in real time using the slope of the yield curve. Relative to the standard one-state predictive regression, the state-switching specification increases both in-sample and out-of-sample performance for the set of popular predictors considered by Welch and Goyal (2008), improving the out-of-sample performance of most predictors in economically meaningful ways. Second, I propose a new aggregate predictor, the Aligned Economic Index, constructed via partial least squares (PLS). Under the state-switching model, the Aligned Economic Index exhibits statistically and economically significant predictive power in sample and out of sample, and it outperforms widely used benchmark predictors and alternative predictor-combination methods.
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The works this paper leans on most, across its whole bibliography — not restricted to papers in our corpus. Ranked by composite intensity, which combines how often a work is mentioned, how many sections mention it, and how much of that falls in the main text rather than the appendix.
| Reference | Intensity | Mentions | Sections | Main text | |
|---|---|---|---|---|---|
| 1 | Welch, Ivo and Goyal, Amit (2008) A Comprehensive Look at the Empirical Performance of Equity Premium Prediction | 1.000 | 9 | 5 | 100% |
| 2 | Devpura, Nandini and Kumar, Praveen and Sunila, S (2018) Is Stock Return Predictability Time-Varying? | 0.928 | 4 | 3 | 100% |
| 3 | Campbell, John Y. and Thompson, Samuel B (2008) Predicting Excess Stock Returns Out of Sample: Can Anything Beat the Historical Average? | 0.693 | 5 | 1 | 100% |
| 4 | Dangl, Thomas and Halling, Michael (2012) Predictive Regressions with Time-Varying Coefficients | 0.644 | 2 | 2 | 100% |
| 5 | Henkel, Samuli J. and Martin, John S. and Nardari, Federico (2011) Time-Varying Short-Horizon Predictability | 0.644 | 2 | 2 | 100% |
| 6 | Huang, Dashan and Jiang, Feng and Tu, Jun and Zhou, Guofu (2015) Investor Sentiment Aligned: A Powerful Predictor of Stock Returns | 0.644 | 2 | 2 | 100% |
| 7 | Lewellen, Jonathan (2004) Predicting Returns with Financial Ratios | 0.644 | 2 | 2 | 100% |
| 8 | Sander, Magnus (2018) Market Timing over the Business Cycle | 0.644 | 2 | 2 | 100% |
| 9 | Rapach, David E. and Strauss, Jack K. and Zhou, Guofu (2010) Out-of-Sample Equity Premium Prediction: Combination Forecasts and Links to the Real Economy | 0.585 | 3 | 1 | 100% |
| 10 | Kelly, Bryan and Pruitt, Seth (2015) The Three-Pass Regression Filter: A New Approach to Forecasting Using Many Predictors | 0.511 | 2 | 2 | 50% |
Showing the top 10 of 33 scored citations.