On the long-run properties of income and stock prices: the stability of the “golden ratios”

James Dean and Joshua Hall

Journal of Financial Economic Policy, 2024, vol. 16, issue 3, 315-329

Abstract: Purpose - The challenge of predicting changes in aggregate income and stock prices is one that has occupied the research agendas of economists. This paper aims to use the consumption–income ratio and the dividend–price ratio to predict future income and stock prices. Design/methodology/approach - To examine the stability of the consumption–income ratio and the dividend–price ratio, the authors run a two-variable, two-lag reduced-form VAR in the vein of Cochrane (1994), using a lag of each respective ratio as exogenous to the VAR. Additionally, the authors estimate an AR(4) model for income and prices. Findings - The consumption–income ratio and the dividend–price ratio remain key to understanding future movements in income and stock prices. The consumption–income ratio significantly predicts future income in the USA, and aggregate income is easier to predict than consumption in the VAR model. The dividend–price ratio does not significantly predict future price growth. Consumption and dividend shocks have lasting impacts on income and prices. Originality/value - The consumption–income ratio and the dividend–price ratio are still key to understanding future movements in income and stock prices. The consumption–income ratio significantly predicts future income in the USA, and aggregate income is easier to predict than consumption in the VAR model. However, the dividend–price ratio does not significantly predict future price growth, a change from previous research from the 1990s, despite the increasing complexity of stock markets. Consumption and dividend shocks have lasting impacts on income and prices and appear to be significant drivers in both the short- and long-run variance in income and prices.

Keywords: Financial markets; Asset pricing; Time-series models; C22; E21; E32; G12; G14 (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:eme:jfeppp:jfep-12-2023-0388

DOI: 10.1108/JFEP-12-2023-0388

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