Unemployment and aggregate stock returns

Victoria Atanasov

Journal of Banking & Finance, 2021, vol. 129, issue C

Abstract: This paper presents new evidence on the predictability of aggregate stock market returns by a labor market based economic indicator–the unemployment gap–which is defined as the difference between the actual unemployment rate and its estimated trend. The unemployment gap emerges as a strong predictor of both raw stock returns and excess stock returns, in the U.S. and in international data. In addition, fluctuations in the unemployment gap are tightly linked to cyclical variation in risk preferences. A widening of the unemployment gap, i.e. a rise in the unemployment rate relative to its trend, is associated with a rise in risk aversion and higher excess returns. The results support the view that the expected equity risk premiums arise as a rational response of economic agents to changes in the investment opportunities.

Keywords: Time-varying stock returns; Predictability; Unemployment gap (search for similar items in EconPapers)
JEL-codes: G12 G15 G17 (search for similar items in EconPapers)
Date: 2021
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Citations: View citations in EconPapers (10)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:129:y:2021:i:c:s0378426621001187

DOI: 10.1016/j.jbankfin.2021.106159

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