An Empirical Analysis Of Stock Equity Risk Premium In China’s Stock Market Based On FAR Model

In this paper, we study the equity risk premium in China’s stock market.Equity risk premium is the difference between the market portfolio or the average risk stock return and the risk-free interest rate. The study of equity risk premium can find the potential value of the stock and guide investors to make rational investment and provide help for their correct investment. So it is meaningful to study the equity risk premium. Firstly, factor augmented regression model are introduced from the angle of parameter estimation and variable selection, then the forecast index system of equity risk premium are established with the selection of 36 macroeconomic indicators,4 financial indicators, later use penalized least squares (PLS) model and FAR model to establish equity risk premium forecasting model (the data used here are monthly data from June 2005 to December 2015), compare the model built by these two methods based on sample data from the angle of MSE and predication performance. By comparison, we derived the MSE and predication performance of model (a combination of hard threshold and window selection model) constructed by FAR method is the best. The predication performance of PLS(X, W) model built by penalized least squares (PLS) method which both macroeconomic indicators and financial indicators are included is the best, at the same time according to model constructed by PLS method, we conclude that the macroeconomic indicators of the producer price index、household savings、the savings deposit and freight volume and the financial indicators of closing price and trading volume have important influence on the Shanghai and Shenzhen 300 equity risk premium.At last, give some suggestions.