The consumption-wealth ratio and asset returns : the Euro Area, the UK and the US

Ricardo Magalhaes Sousa

25 citations0/0 files storedRePEc: Research Papers in Economics

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Financial Markets and Investment Strategies Monetary Policy and Economic Impact Market Dynamics and Volatility

Abstract

In this paper, I assess the forecasting power of the residuals of the trend relationship among consumption, aggregate wealth, and labour income for stock returns and government bond yields in the euro area, the UK and the US . I find that when stock returns are expected to be higher in the future, forward-looking investors will temporarily allow consumption to rise. As for bond returns, when government bonds are seen as a component of asset wealth, then investors react in the same manner. If, however, investors perceive the increase in bond returns as signalling a future rise in taxes or a deterioration of public finances, then they will let consumption fall temporarily below its equilibrium level.

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References

1987Co-Integration and Error Correction: Representation, Estimation, and Testing 1979Distribution of the Estimators for Autoregressive Time Series with a Unit Root 1964CAPITAL ASSET PRICES: A THEORY OF MARKET EQUILIBRIUM UNDER CONDITIONS OF RISK*1988Testing for a Unit Root in Time Series Regression 1992The Cross-Section of Expected Stock Returns 1970EFFICIENT CAPITAL MARKETS: A REVIEW OF THEORY AND EMPIRICAL WORK*1991Estimation and Hypothesis Testing of Cointegration Vectors in Gaussian Vector Autoregressive Models 1975THE VALUATION OF RISK ASSETS AND THE SELECTION OF RISKY INVESTMENTS IN STOCK PORTFOLIOS AND CAPITAL BUDGETS**This paper is another in a series of interrelated theoretical and statistical studies of corporate financial and investment policies being made under grants from the Rockefeller Foundation, and more recently the Ford Foundation, to the Harvard Business School. The generous support for this work is most gratefully acknowledged. The author is also much indebted to his colleagues Professors Bishop, Christenson, Kahr, Raiffa, and (especially) Schlaifer, for extensive discussion and commentary on an earlier draft of this paper; but responsibility for any errors or imperfections remains strictly his own.[Professor Sharpe's paper, “Capital Asset Prices: A Theory of Market Equilibrium Under Conditions of Risk” (Journal of Finance, September 1964) appeared after this paper was in final form and on its way to the printers. My first section, which parallels the first half of his paper (with corresponding conclusions), sets the algebraic framework for sections II, III and VI, (which have no counterpart in his paper) and for section IV on the equilibrium prices of risk assets, concerning which our results differ significantly for reasons which will be explored elsewhere. Sharpe does not take up the capital budgeting problem developed in section V below.]

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