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Hard Times

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  • Campbell, John Y.
  • Giglio, Stefano
  • Polk, Christopher

Abstract

We show that the stock market downturns of 2000–2002 and 2007–2009 have very different proximate causes. The early 2000s saw a large increase in the discount rates applied to profits by rational investors, while the late 2000s saw a decrease in rational expectations of future profits. We reach these conclusions by using a VAR model of aggregate stock returns and valuations, estimated both without restrictions and imposing the cross-sectional restrictions of the intertemporal capital asset pricing model (ICAPM). Our findings imply that the 2007–2009 downturn was particularly serious for rational long-term investors, whose losses were not offset by improving stock return forecasts as in the previous recession. (JEL G12, N22)

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Paper provided by Harvard University Department of Economics in its series Scholarly Articles with number 12172786.

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Date of creation: 2013
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Publication status: Published in Review of Asset Pricing Studies
Handle: RePEc:hrv:faseco:12172786

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  1. Todd E. Clark & Kenneth D. West, 2005. "Approximately normal tests for equal predictive accuracy in nested models," Research Working Paper, Federal Reserve Bank of Kansas City RWP 05-05, Federal Reserve Bank of Kansas City.
  2. Francis X. Diebold & Robert S. Mariano, 1994. "Comparing Predictive Accuracy," NBER Technical Working Papers, National Bureau of Economic Research, Inc 0169, National Bureau of Economic Research, Inc.
  3. John Y. Campbell & Christopher Polk & Tuomo Vuolteenaho, 2010. "Growth or Glamour? Fundamentals and Systematic Risk in Stock Returns," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 23(1), pages 305-344, January.
  4. Todd E. Clark & Kenneth D. West, 2004. "Using out-of-sample mean squared prediction errors to test the Martingale difference hypothesis," Research Working Paper, Federal Reserve Bank of Kansas City RWP 04-03, Federal Reserve Bank of Kansas City.
  5. Amit Goval & Ivo Welch, 2004. "A Comprehensive Look at the Empirical Performance of Equity Premium Prediction," NBER Working Papers, National Bureau of Economic Research, Inc 10483, National Bureau of Economic Research, Inc.
  6. Martin Lettau & Sydney C. Ludvigson, 2011. "Shocks and Crashes," NBER Working Papers, National Bureau of Economic Research, Inc 16996, National Bureau of Economic Research, Inc.
  7. Epstein, Larry G & Zin, Stanley E, 1991. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: An Empirical Analysis," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 99(2), pages 263-86, April.
  8. Campbell, John Y, 1991. "A Variance Decomposition for Stock Returns," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 101(405), pages 157-79, March.
  9. John Y. Campbell, 1995. "Understanding Risk and Return," Harvard Institute of Economic Research Working Papers, Harvard - Institute of Economic Research 1711, Harvard - Institute of Economic Research.
  10. Campbell, John & Thompson, Samuel P., 2008. "Predicting Excess Stock Returns Out of Sample: Can Anything Beat the Historical Average?," Scholarly Articles, Harvard University Department of Economics 2622619, Harvard University Department of Economics.
  11. Engsted, Tom & Pedersen, Thomas Q. & Tanggaard, Carsten, 2012. "Pitfalls in VAR based return decompositions: A clarification," Journal of Banking & Finance, Elsevier, Elsevier, vol. 36(5), pages 1255-1265.
  12. Whitney Newey & Richard Smith, 2003. "Higher order properties of GMM and generalised empirical likelihood estimators," CeMMAP working papers, Centre for Microdata Methods and Practice, Institute for Fiscal Studies CWP04/03, Centre for Microdata Methods and Practice, Institute for Fiscal Studies.
  13. Polk, Christopher & Thompson, Samuel & Vuolteenaho, Tuomo, 2006. "Cross-sectional forecasts of the equity premium," Journal of Financial Economics, Elsevier, Elsevier, vol. 81(1), pages 101-141, July.
  14. John H. Cochrane, 2006. "The Dog That Did Not Bark: A Defense of Return Predictability," NBER Working Papers, National Bureau of Economic Research, Inc 12026, National Bureau of Economic Research, Inc.
  15. Ravi Bansal & Dana Kiku & Ivan Shaliastovich & Amir Yaron, 2012. "Volatility, the Macroeconomy and Asset Prices," NBER Working Papers, National Bureau of Economic Research, Inc 18104, National Bureau of Economic Research, Inc.
  16. Merton, Robert C, 1973. "An Intertemporal Capital Asset Pricing Model," Econometrica, Econometric Society, Econometric Society, vol. 41(5), pages 867-87, September.
  17. John H. Cochrane, 2011. "Presidential Address: Discount Rates," Journal of Finance, American Finance Association, American Finance Association, vol. 66(4), pages 1047-1108, 08.
  18. John Y. Campbell, 1992. "Intertemporal Asset Pricing Without Consumption Data," NBER Working Papers, National Bureau of Economic Research, Inc 3989, National Bureau of Economic Research, Inc.
  19. Long Chen & Xinlei Zhao, 2009. "Return Decomposition," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 22(12), pages 5213-5249, December.
  20. Schroder, Mark & Skiadas, Costis, 1999. "Optimal Consumption and Portfolio Selection with Stochastic Differential Utility," Journal of Economic Theory, Elsevier, Elsevier, vol. 89(1), pages 68-126, November.
  21. Arthur F. Burns & Wesley C. Mitchell, 1946. "Measuring Business Cycles," NBER Books, National Bureau of Economic Research, Inc, National Bureau of Economic Research, Inc, number burn46-1.
  22. Epstein, Larry G & Zin, Stanley E, 1989. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework," Econometrica, Econometric Society, Econometric Society, vol. 57(4), pages 937-69, July.
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Cited by:
  1. Botshekan, Mahmoud & Kräussl, Roman & Lucas, André, 2010. "Cash flow and discount rate risk in up and down markets: What is actually priced?," CFS Working Paper Series, Center for Financial Studies (CFS) 2010/20, Center for Financial Studies (CFS).
  2. Maio, Paulo, 2013. "Return decomposition and the Intertemporal CAPM," Journal of Banking & Finance, Elsevier, Elsevier, vol. 37(12), pages 4958-4972.
  3. repec:dgr:uvatin:2010116 is not listed on IDEAS
  4. Thomas Nitschka, 2014. "The Good? The Bad? The Ugly? Which news drive (co)variation in Swiss and US bond and stock excess returns?," Working Papers, Swiss National Bank 2014-01, Swiss National Bank.

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