In this task, you are required to build time-series predictive models (full-sample and real-time) to predict
future equity premium i.e. equity return in excess of the risk-free rate. You will use term structure of
interest rates and default yield spreads as your predictors.
- Download Predictor2018.csv from Blackboard.
- The file contains various aggregate economic variables from Jan 1871 to Dec 2018. More details
about the variable definition can be found in Welch and Goyal (2008).
- You want to build predictive models on monthly frequency data. Your sample period is from Jan
1926 to Dec 2018.
- You are interested in the following variables:
• Rfree: Risk-free rate,
• tbl: Treasury-bill rate,
• lty: Long-term government bond yield,
• AAA: AAA-rate coporate bond yield,
• BAA: BAA-rated corporate bond yield,
• CRSP_SPvw: S/P 500 stock market returns including dividends.
1.3 The Variables
A. Construct the term structure of interest rates (tms) and default yield spreads (dfy) variables. (5