Edith Cowan University
School of Accounting, Finance and Economics
This paper provides a forecasting methodology for estimating the market risk premium in Australia. We employ an in-sample and out-of-sample forecast estimate using various dividend yield measures. The lagged dividend yield model is used to predict future equity premia on a data series that includes the top 85 percent of the Australian stock market. An important concern in this paper is the accuracy of dividend yield in forecasting the equity premium in the Australian market. We find that the level of predictability in the later part of the series is very weak compared to in-sample prediction during the 70s and 80s. This finding is similar to many claims in most U.S. studies that find that other macroeconomic factors such as the business cycle, inflation and the level of economic growth can play a part in the prediction process.