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Consumption growth and time-varying expected stock returns

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  • Stig Vinther Møller

    ()
    (School of Economics and Management, University of Aarhus, Denmark and CREATES)

Abstract

When the consumption growth rate is measured based upon fourth quarter data, it tracks predictable variation in future excess stock returns. Low fourth quarter consumption growth rates predict high future excess stock returns such that expected returns are high at business cycle troughs and low at business cycle peaks. The consumption growth rate loses predictive power when it is measured based upon other quarters. This is consistent with the insight of Jagannathan and Wang (2007) that investors tend to review their consumption and investment plans during the end of each calendar year, and at possibly random times in be- tween. The consumption growth rate measured based upon fourth quarter data is a much stronger predictive variable than benchmark predictive variables such as the dividend-price ratio, the term spread, and the default spread.

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Bibliographic Info

Paper provided by School of Economics and Management, University of Aarhus in its series CREATES Research Papers with number 2008-40.

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Length: 13
Date of creation: 02 Sep 2008
Date of revision:
Handle: RePEc:aah:create:2008-40

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Web page: http://www.econ.au.dk/afn/

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Keywords: Return predictability; Consumption growth;

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  1. Goetzmann, W.N., 1990. "Testing The Predictive Power Of Dividend Yields," Papers fb-_90-12, Columbia - Graduate School of Business.
  2. Robert J. Shiller & John Y. Campbell, 1986. "The Dividend-Price Ratio and Expectations of Future Dividends and Discount Factors," Cowles Foundation Discussion Papers 812, Cowles Foundation for Research in Economics, Yale University.
  3. Fama, Eugene F. & French, Kenneth R., 1989. "Business conditions and expected returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 25(1), pages 23-49, November.
  4. Whitney K. Newey & Kenneth D. West, 1986. "A Simple, Positive Semi-Definite, Heteroskedasticity and AutocorrelationConsistent Covariance Matrix," NBER Technical Working Papers 0055, National Bureau of Economic Research, Inc.
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  6. Nelson, Charles R & Kim, Myung J, 1993. " Predictable Stock Returns: The Role of Small Sample Bias," Journal of Finance, American Finance Association, vol. 48(2), pages 641-61, June.
  7. Ravi Jagannathan & Yong Wang, 2007. "Lazy Investors, Discretionary Consumption, and the Cross-Section of Stock Returns," Journal of Finance, American Finance Association, vol. 62(4), pages 1623-1661, 08.
  8. Fama, Eugene F. & French, Kenneth R., 1988. "Dividend yields and expected stock returns," Journal of Financial Economics, Elsevier, vol. 22(1), pages 3-25, October.
  9. Stambaugh, Robert F., 1999. "Predictive regressions," Journal of Financial Economics, Elsevier, vol. 54(3), pages 375-421, December.
  10. Kothari, S. P. & Shanken, Jay, 1997. "Book-to-market, dividend yield, and expected market returns: A time-series analysis," Journal of Financial Economics, Elsevier, vol. 44(2), pages 169-203, May.
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Cited by:
  1. Andreas Fuster & Benjamin Hebert & David Laibson, 2011. "Natural Expectations, Macroeconomic Dynamics, and Asset Pricing," NBER Working Papers 17301, National Bureau of Economic Research, Inc.

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