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
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: Suggested Citation
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