Consumption, Aggregate Wealth and Expected Stock Returns

Martin Lettau and Sydney Ludvigson

No 2223, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: This paper studies the role of detrended wealth in predicting stock returns. We call a transitory movement in wealth one that produces a deviation from its shared trend with consumption and labor income. Using quarterly stock market data we find that these trend deviations in wealth are strong predictors of both real stock returns and excess returns over a Treasury bill rate. We also find that this variable is a better forecaster of future returns at short and intermediate horizons than is the dividend yield, the earnings yield, the dividend payout ratio and several other popular forecasting variables. Why should wealth, detrended in this way, forecast asset returns? We show that a wide class of optimal models of consumer behavior imply that the log consumption-aggregate (human and nonhuman) wealth ratio forecasts the expected return on aggregate wealth, or the market portfolio. Although this ratio is not observable, we demonstrate that its important predictive components may be expressed in terms of observable variables, namely in terms of consumption, nonhuman wealth and labor income. The framework implies that these variables are cointegrated, and that deviations from this shared trend summarize agents' expectations of future returns on the market portfolio.

Keywords: Co Integration; Consumption; Forecasting; Human Capital; Stock Returns; Wealth (search for similar items in EconPapers)
JEL-codes: E21 G10 (search for similar items in EconPapers)
Date: 1999-09
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

Downloads: (external link)
http://www.cepr.org/active/publications/discussion_papers/dp.php?dpno=2223 (application/pdf)
CEPR Discussion Papers are free to download for our researchers, subscribers and members. If you fall into one of these categories but have trouble downloading our papers, please contact us at subscribers@cepr.org

Related works:
Journal Article: Consumption, Aggregate Wealth, and Expected Stock Returns (2001)
Working Paper: Consumption, aggregate wealth and expected stock returns (1999)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:cpr:ceprdp:2223

Ordering information: This working paper can be ordered from
http://www.cepr.org/ ... ers/dp.php?dpno=2223

Access Statistics for this paper

More papers in CEPR Discussion Papers from C.E.P.R. Discussion Papers Centre for Economic Policy Research, 33 Great Sutton Street, London EC1V 0DX.
Bibliographic data for series maintained by ().