Business Cycles, Regime Shifts, and Return Predictability

Wei Yang

Journal of Financial and Quantitative Analysis, 2023, vol. 58, issue 7, 3058-3084

Abstract: Consistent with the empirical properties of the consumption data, I develop a model in which consumption and dividend growth follow regime-switching dynamics. I show that regime-shift risk is priced in the model. Regime-shift risk exhibits dominant influence on asset prices: It generates a high equity premium and also induces time-varying risk premiums. The model explains major business cycle-dependent asset market phenomena and, in particular, the stronger predictability of stock returns during recessions.

Date: 2023
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