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Risk premium, time varying GARCH, predictability of stock returns
This paper makes use of time-varying parameter GARCH-M model to estimate the risk aversion parameter for the South African stock market. The paper further compares the forecasts performance of a time-varying risk premium model with that of a constant risk premium model in predicting stock market returns on the South African stock exchange. The findings of the paper show that risk premium is time varying and indicate that stock market in South Africa is vulnerable to external shocks. Moreover, the paper finds that the time-varying GARCH-M model outperforms the fixed parameter GARCH-M model in predicting stock returns when short-term forecast horizons are used.