Labor income risk and asset returns
AbstractThis paper shows, from the consumer’s budget constraint, that expected future labor income growth rates and the residuals of the cointegration relation among log consumption, log asset wealth and log current labor income (summarized by the variable cay of Lettau and Ludvigson (2001a)), should help predict U.S. quarterly stock market returns and explain the cross-section of average returns. I …nd that a) ‡uctuations in expected future labor income are a strong predictor of both real stock returns and excess returns over a Treasury bill rate, b) when this variable is used as conditioning information for the Consumption Capital Asset Pricing Model (CCAPM), the resulting linear factor model explains four …fth of the variation in observed average returns across the Fama and French (25) portfolios and prices correctly the small growth portfolio. The paper also …nds that about one third of the variance of returns is predictable, over a horizon of one year, using expected future labor income growth rates and cay jointly as forecasting variables.
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Bibliographic InfoPaper provided by London School of Economics and Political Science, LSE Library in its series LSE Research Online Documents on Economics with number 4811.
Length: 55 pages
Date of creation: May 2007
Date of revision:
Human Capital; Labor Income Risk; Expected Returns; Consumption Capital;
Find related papers by JEL classification:
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution
- E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
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