We embed the budget constraints of the private, public, and external sectors within the aggregate budget constraint of the economy to examine whether valuation ratios in one sector forecast real returns and cash-flow growth in others. Exploiting the cross-sector restrictions implied by the aggregate constraint, we show that fluctuations in the government surplus-to-debt ratio robustly predict equity returns. The magnitude of this cross-sector predictability is on par with the ownsector predictability associated with the dividend-price ratio. We then develop a model in which distortionary taxes generate these patterns and use the cross-sector forecasts to calibrate the implied size of the tax distortions

Gao, Junxiong; Plazzi, Alberto; Valkanov, Rossen I.; Xu, Yan

We embed the budget constraints of the private, public, and external sectors within the aggregate budget constraint of the economy to examine whether valuation ratios in one sector forecast real returns and cash-flow growth in others. Exploiting the cross-sector restrictions implied by the aggregate constraint, we show that fluctuations in the government surplus-to-debt ratio robustly predict equity returns. The magnitude of this cross-sector predictability is on par with the ownsector predictability associated with the dividend-price ratio. We then develop a model in which distortionary taxes generate these patterns and use the cross-sector forecasts to calibrate the implied size of the tax distortions

Junxiong Gao, Alberto Plazzi, Rossen I. Valkanov and Yan Xu
Additional contact information
Junxiong Gao: Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF)
Alberto Plazzi: Universita' della Svizzera italiana; Swiss Finance Institute
Rossen I. Valkanov: University of California, San Diego (UCSD) - Rady School of Management
Yan Xu: HKU, Faculty of Business and Economics

No 25-102, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Keywords: public debt; fiscal imbalances; cross-sector predictability; output distortion; equity predictability (search for similar items in EconPapers)
JEL-codes: E62 G12 G17 (search for similar items in EconPapers)
Pages: 81 pages
Date: 2025-12
New Economics Papers: this item is included in nep-mac
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