Consumption, aggregate wealth, and expected stock returns

Martin Lettau, Sydney Ludvigson

    Research output: Contribution to journalArticle

    Abstract

    This paper studies the role of fluctuations in the aggregate consumption-wealth ratio for predicting stock returns. Using U.S. quarterly stock market data, we find that these fluctuations in the consumption-wealth ratio 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 dividend payout ratio, and several other popular forecasting variables. Why should the consumption-wealth ratio forecast asset returns? We show that a wide class of optimal models of consumer behavior imply that the log consumption-aggregate wealth (human capital plus asset holdings) ratio summarizes expected returns on aggregate wealth, or the market portfolio. Although this ratio is not observable, we provide assumptions under which its important predictive components for future asset returns may be expressed in terms of observable variables, namely in terms of consumption, asset holdings 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.

    Original languageEnglish (US)
    Pages (from-to)815-849
    Number of pages35
    JournalJournal of Finance
    Volume56
    Issue number3
    DOIs
    StatePublished - 2001

    Fingerprint

    Aggregate consumption
    Stock returns
    Wealth
    Consumption-wealth ratio
    Assets
    Market portfolio
    Fluctuations
    Asset returns
    Stock market
    Deviation
    Real stock returns
    Labor income
    Expected returns
    Consumer behaviour
    Dividend yield
    Dividend payout
    Market data
    Human capital
    Excess returns
    Predictors

    ASJC Scopus subject areas

    • Accounting
    • Finance
    • Economics and Econometrics

    Cite this

    Consumption, aggregate wealth, and expected stock returns. / Lettau, Martin; Ludvigson, Sydney.

    In: Journal of Finance, Vol. 56, No. 3, 2001, p. 815-849.

    Research output: Contribution to journalArticle

    Lettau, Martin ; Ludvigson, Sydney. / Consumption, aggregate wealth, and expected stock returns. In: Journal of Finance. 2001 ; Vol. 56, No. 3. pp. 815-849.
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