Incorporating economic policy uncertainty in US equity premium models: A nonlinear predictability analysis

•Equity premium forecasting analyzed with economic policy uncertainty.•We use monthly out-of-sample of 1909:08-2014:02.•Quantile regression is used to control for nonlinearity.•Misspecified linear model shows no evidence of predictability.•Quantile regression shows predictability below to till the median.

Information on economic policy uncertainty does matter in predicting the US equity premium, especially when accounting for structural instabilities and omitted nonlinearities in their relationship, via a quantile predictive regression approach over the monthly period 1900:1-2014:2. Unlike as suggested by a linear mean-based predictive model, the extended quantile regression model with the incorporation of the EPU proxy, enhances significantly the out-of-sample stock return predictability. This is observed especially when the market is neutral, exhibits a slide or mildly upward trending behavior, yet not when the market appears to turn highly bullish.