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Aggregate consumption-wealth ratio and the cross-section of stock returns: some international evidence

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  • Paul Gao
  • Kevin X.D. Huang

Abstract

We find that the short-term deviations from long-run consumption-wealth relationship (cay) forecast stock market returns and serve as a conditioning variable in the capital asset pricing model (CAPM) for explaining the cross-section of stock returns for the United Kingdom and Japan. Our cross-sectional regressions using cay as a conditioning variable as opposed to using an alternative variable, tay, constructed using calendar time in place of consumption indicate that it is unlikely to be a spurious variable and provides useful information concerning the economic fundamentals. We show that both a consumption-based capital asset pricing model (CCAPM) and a human-capital-augmented capital asset pricing model (HC-CAPM) in conjunction with this conditioning variable can explain much of the cross-section of stock returns in each of the two countries; yet, in terms of relative performance, our results tend to favor the conditional HC-CAPM over the conditional CCAPM for pricing U.K. and Japanese cross-sectional returns.

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Paper provided by Federal Reserve Bank of Kansas City in its series Research Working Paper with number RWP 04-07.

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Date of creation: 2004
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Handle: RePEc:fip:fedkrw:rwp04-07

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Keywords: Capital assets pricing model;

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Cited by:
  1. Cheng-si Zhang & Da-yin Zhang & Jeffery Breece, 2011. "Financial Crisis, Monetary Policy, and Stock Market Volatility in China," Annals of Economics and Finance, Society for AEF, vol. 12(2), pages 371-388, November.
  2. Aono, Kohei & Iwaisako, Tokuo, 2008. "The Consumption-Wealth Ratio, Real Estate Wealth, and the Japanese Stock Market," Discussion Paper Series a504, Institute of Economic Research, Hitotsubashi University.
  3. Jushan Bai & Shuzhong Shi, 2011. "Estimating High Dimensional Covariance Matrices and its Applications," Annals of Economics and Finance, Society for AEF, vol. 12(2), pages 199-215, November.
  4. Aono, Kohei & Iwaisako, Tokuo, 2013. "The consumption–wealth ratio, real estate wealth, and the Japanese stock market," Japan and the World Economy, Elsevier, vol. 25, pages 39-51.
  5. Bin Li & Benjamin Liu & Eduardo Roca, 2010. "An Empirical Investigation of Consumption CAPMs in the Australian Market," Discussion Papers in Finance finance:201011, Griffith University, Department of Accounting, Finance and Economics.

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