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Are Asset Returns Predictable from the National Accounts?

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  • Pierre Lafourcade
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    Abstract

    Rational expectations and the logic of budget constraints imply that the predictability of asset returns hinges on the stability and persistence of households' ratio of saving to asset wealth, not of consumption to total wealth. This misalignment undermines the rationale for Lettau and Ludvigson's estimated cay, a stationary but unduly loose approximation to the true but non-mean-reverting cay. Definitional considerations on saving, assets and returns suggest rehabilitating money in the households'  flow of funds identity. Accounting for money balances in cay restores stationarity, but at the cost of drastically lower persistence and predictive potential. 

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    Paper provided by Netherlands Central Bank, Research Department in its series DNB Working Papers with number 189.

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    Date of creation: Dec 2008
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    Handle: RePEc:dnb:dnbwpp:189

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    1. Palumbo, Michael & Rudd, Jeremy & Whelan, Karl, 2006. "On the Relationships Between Real Consumption, Income, and Wealth," Journal of Business & Economic Statistics, American Statistical Association, vol. 24, pages 1-11, January.
    2. Lettau, Martin & Ludvigson, Sydney, 1999. "Consumption, Aggregate Wealth and Expected Stock Returns," CEPR Discussion Papers 2223, C.E.P.R. Discussion Papers.
    3. John H. Cochrane, 2008. "The Dog That Did Not Bark: A Defense of Return Predictability," Review of Financial Studies, Society for Financial Studies, vol. 21(4), pages 1533-1575, July.
    4. Whelan, Karl, 2006. "Consumption and Expected Asset Returns Without Assumptions About Unobservables," Research Technical Papers 4/RT/06, Central Bank of Ireland.
    5. Martin Lettau & Sydney C. Ludvigson, 2004. "Understanding Trend and Cycle in Asset Values: Reevaluating the Wealth Effect on Consumption," American Economic Review, American Economic Association, vol. 94(1), pages 276-299, March.
    6. Gonzalo, Jesus & Ng, Serena, 2001. "A systematic framework for analyzing the dynamic effects of permanent and transitory shocks," Journal of Economic Dynamics and Control, Elsevier, vol. 25(10), pages 1527-1546, October.
    7. John Y. Campbell & N. Gregory Mankiw, 1989. "Consumption, Income and Interest Rates: Reinterpreting the Time Series Evidence," NBER Chapters, in: NBER Macroeconomics Annual 1989, Volume 4, pages 185-246 National Bureau of Economic Research, Inc.
    8. Jeremy Rudd & Karl Whelan, 2006. "Empirical Proxies for the Consumption-Wealth Ratio," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 9(1), pages 34-51, January.
    9. Hoffmann, Mathias, 2006. "Balanced Growth and Empirical Proxies of the Consumption-Wealth Ratio," Technical Reports 2006,26, Technische Universität Dortmund, Sonderforschungsbereich 475: Komplexitätsreduktion in multivariaten Datenstrukturen.
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