Empirical Asset Pricing with Probability Forecasts

Abstract

We study probability forecasts in the context of cross-sectional asset pricing with a large number of firm characteristics. Empirically, we find that a simple probability forecast model can surprisingly perform as well as a sophisticated probability forecast model, and all of which deliver long-short portfolios whose Sharpe ratios are comparable to those of the widely used return forecasts. Moreover, we show that combining probability forecasts with return forecasts yields superior portfolio performance versus using each type of forecast individually, suggesting that probability forecasts provide valuable information beyond return forecasts for our understanding of the cross-section of stock returns.