Forecasting the cross-sectional stock returns: Evidence from the United Kingdom

The study provides the forecasts of expected returns based on cross-sectional estimates from the Fama-Macbeth regressions in the United Kingdom. We collected the data of listed firms on the London Stock Exchange on the DataStream from January 1980 to December 2020. We analyze the data sample by employing three cross-sectional models' ten-year rolling estimates of Fama-Macbeth slopes. The empirical findings demonstrate that an investor can derive a composite estimate of the expected return by integrating various company-specific variables in real-time. Model 1 indicates that the expected-return estimates have a predictive slope for future monthly returns of 95.07%, with a standard error of 0.1981. Moreover, model 2 and model 3 report the predictability of returns are 77.57% and 76.94%. In short, our empirical evidence suggests that investors and stakeholders may consider using model 1 to estimate the cost of equity due to its simplicity and effective prediction capability. Our findings are consistent with trade-off theory and prior literature.