Consumption, (Dis)Aggregate Wealth, and Asset Returns

University of Minho, NIPE Working Paper No. 9/2005

42 Pages Posted: 13 May 2005 Last revised: 29 Jan 2009

See all articles by Ricardo M. Sousa

Ricardo M. Sousa

University of Minho; Economic Policies Research Unit (NIPE); London School of Economics & Political Science (LSE) - Financial Markets Group; London School of Economics

Date Written: October 31, 2005

Abstract

In this work, I show, from the consumer's budget constraint, that the residuals of the trend relationship among consumption, financial wealth, housing wealth and labor income (summarized by the variable cday) should predict better U.K. quarterly stock market returns than a variable like cay from Lettau and Ludvigson (2001), which considers aggregate wealth instead.

I show that the superior forecasting power of cday is due to: (i) its ability to track the changes in the composition of asset wealth; and (ii) the faster rate of convergence of the coefficients to the long-run equilibrium parameters.

Unlike Lettau and Ludvigson (2001, 2004), the results suggest that, while financial wealth shocks are mainly transitory, fluctuations in housing wealth are very persistent. Governments and central banks should, therefore, pay special attention to the behavior of housing markets when defining macroeconomic policies.

Keywords: Financial wealth, housing wealth, consumption, expected returns

JEL Classification: E21, E44, D12

Suggested Citation

Sousa, Ricardo Magalhaes, Consumption, (Dis)Aggregate Wealth, and Asset Returns (October 31, 2005). University of Minho, NIPE Working Paper No. 9/2005, Available at SSRN: https://ssrn.com/abstract=720182 or http://dx.doi.org/10.2139/ssrn.720182

Ricardo Magalhaes Sousa (Contact Author)

University of Minho ( email )

Campus Gualtar
Braga, 4710-057
Portugal
+351253604584 (Phone)
+351253676375 (Fax)

HOME PAGE: http://www.eeg.uminho.pt/economia/rjsousa

Economic Policies Research Unit (NIPE) ( email )

Campus de Gualtar
Braga, 4710-057
Portugal
+351253604584 (Phone)
+351253676375 (Fax)

HOME PAGE: http://www.eeg.uminho.pt/economia/rjsousa

London School of Economics & Political Science (LSE) - Financial Markets Group ( email )

Houghton Street
London WC2A 2AE
United Kingdom

London School of Economics ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

HOME PAGE: http://econ.lse.ac.uk