Empirical Proxies for the Consumption-Wealth Ratio

Jeremy Rudd and Karl Whelan ()
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Jeremy Rudd: Board of Governors of the Federal Reserve System

Review of Economic Dynamics, 2006, vol. 9, issue 1, 34-51

Abstract: Using a log-linearized approximation to an aggregate budget constraint, it is possible to show that the ratio of consumption to total (human and non-human) wealth summarizes agents' expectations concerning both future labor income and future asset returns. In a series of recent papers, Lettau and Ludvigson construct an empirical analogue to the consumption-wealth ratio by approximating total wealth with a linear combination of labor income and observable non-human wealth. If valid, this framework suggests that consumption, assets, and labor income will be cointegrated. We demonstrate, however, that standard tests fail to reject the hypothesis of no cointegration once one employs measures of consumption, assets, and labor income that are jointly consistent with an underlying budget constraint. We also show that deviations of consumption, assets, and income from an estimated common trend are unable to predict future excess returns on stocks out of sample once theoretically consistent measures are used. (Copyright: Elsevier)

Keywords: Budget constraint; Return forecastability; Cointegration; cay (search for similar items in EconPapers)
JEL-codes: E21 (search for similar items in EconPapers)
Date: 2006
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Citations: View citations in EconPapers (45)

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Working Paper: Empirical proxies for the consumption–wealth ratio (2006)
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