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Consumption and stock prices: Evidence from a small international panel

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  • McMillan, David G.
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    Abstract

    This paper examines the relationship between consumption growth and the stock market for the G7 markets primarily using panel estimation techniques. We consider whether consumption growth is affected by stock returns and the dividend yield. The use of returns determines the existence of a wealth effect, while the use of the dividend yield can determine whether consumption is affected by short-term deviations of prices from fundamental value (bubbles) as well as expectations of future economic behaviour. Panel unit root tests confirm the stationarity of each variable, although high persistence is noted in the dividend yield. Regression results support a significant relationship between the dividend yield and consumption growth, such that a fall in the yield (high prices relative to dividends) is associated with higher future consumption. This result is robust across different empirical specifications to control for high persistence and possible cross-sectional dependence. Results for returns differ across the specifications but are typically supportive of a positive relationship. Overall, we argue our results support the view that when stock prices deviate from their fundamental path this has an effect on future consumption. This may have important implication with regard to how policy-makers deal with stock market bubbles, both positive and negative.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Macroeconomics.

    Volume (Year): 36 (2013)
    Issue (Month): C ()
    Pages: 76-88

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    Handle: RePEc:eee:jmacro:v:36:y:2013:i:c:p:76-88

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    Web page: http://www.elsevier.com/locate/inca/622617

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    Keywords: Consumption; Stock returns; Dividend yield; Panel;

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