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Stock Returns and Expected Business Conditions: Half a Century of Direct Evidence

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  • Sean D. Campbell
  • Francis X. Diebold

Abstract

We explore the macro/finance interface in the context of equity markets. In particular, using half a century of Livingston expected business conditions data we characterize directly the impact of expected business conditions on expected excess stock returns. Expected business conditions consistently affect expected excess returns in a statistically and economically significant counter-cyclical fashion: depressed expected business conditions are associated with high expected excess returns. Moreover, inclusion of expected business conditions in otherwisestandard predictive return regressions substantially reduces the explanatory power of the conventional financial predictors, including the dividend yield, default premium, and term premium, while simultaneously increasing R-squared. Expected business conditions retain predictive power even after controlling for an important and recently introduced non-financial predictor, the generalized consumption/wealth ratio, which accords with the view that expected business conditions play a role in asset pricing different from and complementary to that of the consumption/wealth ratio. We argue that time-varying expected business conditions likely capture time-varying risk, while time-varying consumption/wealth may capture time-varying risk aversion.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 11736.

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Date of creation: Nov 2005
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Publication status: published as Campbell, Sean and Francis Diebold. "Stock Returns and Expected Business Conditions: Half a Century of Direct Evidence." Journal of Business and Economic Statistics 27, 2 (April 1, 2009): 266-278.
Handle: RePEc:nbr:nberwo:11736

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  1. Martin Lettau & Sydney Ludvigson, 1999. "Resurrecting the (C)CAPM: a cross-sectional test when risk premia are time-varying," Staff Reports, Federal Reserve Bank of New York 93, Federal Reserve Bank of New York.
  2. Torben G. Andersen & Tim Bollerslev & Francis X. Diebold & Jin (Ginger) Wu, 2005. "A Framework for Exploring the Macroeconomic Determinants of Systematic Risk," PIER Working Paper Archive 05-009, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
  3. Hamilton, James D & Gang, Lin, 1996. "Stock Market Volatility and the Business Cycle," Journal of Applied Econometrics, John Wiley & Sons, Ltd., John Wiley & Sons, Ltd., vol. 11(5), pages 573-93, Sept.-Oct.
  4. Peter F. Christoffersen & Francis X. Diebold, . "Optimal Prediction Under Asymmetric Loss," CARESS Working Papres, University of Pennsylvania Center for Analytic Research and Economics in the Social Sciences 97-20, University of Pennsylvania Center for Analytic Research and Economics in the Social Sciences.
  5. Martin Lettau, 2001. "Consumption, Aggregate Wealth, and Expected Stock Returns," Journal of Finance, American Finance Association, American Finance Association, vol. 56(3), pages 815-849, 06.
  6. Fama, Eugene F. & French, Kenneth R., 1988. "Dividend yields and expected stock returns," Journal of Financial Economics, Elsevier, Elsevier, vol. 22(1), pages 3-25, October.
  7. G. William Schwert, 1990. "Why Does Stock Market Volatility Change Over Time?," NBER Working Papers 2798, National Bureau of Economic Research, Inc.
  8. John Y. Campbell, 1990. "A Variance Decomposition for Stock Returns," NBER Working Papers 3246, National Bureau of Economic Research, Inc.
  9. Gultekin, N Bulent, 1983. " Stock Market Returns and Inflation Forecasts," Journal of Finance, American Finance Association, American Finance Association, vol. 38(3), pages 663-73, June.
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  14. Ferson, Wayne E & Harvey, Campbell R, 1991. "The Variation of Economic Risk Premiums," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 99(2), pages 385-415, April.
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  16. John H. Cochrane & Monika Piazzesi, 2005. "Bond Risk Premia," American Economic Review, American Economic Association, American Economic Association, vol. 95(1), pages 138-160, March.
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  23. Miller, Edward M, 1977. "Risk, Uncertainty, and Divergence of Opinion," Journal of Finance, American Finance Association, American Finance Association, vol. 32(4), pages 1151-68, September.
  24. John Y. Campbell & John Cochrane, 1999. "Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 107(2), pages 205-251, April.
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Cited by:
  1. Torben G. Andersen & Tim Bollerslev & Peter F. Christoffersen & Francis X. Diebold, 2011. "Financial Risk Measurement for Financial Risk Management," PIER Working Paper Archive 11-037, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
  2. Pakos, Michal, 2013. "Long-Run Risk and Hidden Growth Persistence," MPRA Paper 47217, University Library of Munich, Germany.
  3. M. Barari & Brian Lucey & S. Voronkova, 2008. "Reassessing co-movements among G7 equity markets: evidence from iShares," Applied Financial Economics, Taylor & Francis Journals, Taylor & Francis Journals, vol. 18(11), pages 863-877.
  4. Fong, Wai Mun, 2012. "Do expected business conditions explain the value premium?," Journal of Financial Markets, Elsevier, Elsevier, vol. 15(2), pages 181-206.
  5. repec:ipg:wpaper:28 is not listed on IDEAS
  6. Safari, Meysam & TahmooresPour, Reza, 2011. "Moderation Effect of Market Condition on the Relationship between Dividend Yield and Stock Return," MPRA Paper 28913, University Library of Munich, Germany.
  7. Mordecai Kurz & Maurizio Motolese, 2007. "Diverse Beliefs and Time Variability of Risk Premia," Discussion Papers, Stanford Institute for Economic Policy Research 06-044, Stanford Institute for Economic Policy Research.
  8. repec:dgr:uvatin:2010115 is not listed on IDEAS
  9. Paye, Bradley S., 2012. "‘Déjà vol’: Predictive regressions for aggregate stock market volatility using macroeconomic variables," Journal of Financial Economics, Elsevier, Elsevier, vol. 106(3), pages 527-546.
  10. Sjoerd van den Hauwe & Dick van Dijk & Richard Paap, 2011. "Bayesian Forecasting of Federal Funds Target Rate Decisions," Tinbergen Institute Discussion Papers 11-093/4, Tinbergen Institute.
  11. Conrad, Christian & Loch, Karin, 2012. "Anticipating Long-Term Stock Market Volatility," Working Papers 0535, University of Heidelberg, Department of Economics.
  12. Marc Joëts, 2012. "Energy price transmissions during extreme movements," EconomiX Working Papers 2012-38, University of Paris West - Nanterre la Défense, EconomiX.
  13. Nuno Silva, 2013. "Equity Premia Predictability in the EuroZone," GEMF Working Papers 2013-22, GEMF - Faculdade de Economia, Universidade de Coimbra.
  14. Baetje, Fabian & Menkhoff, Lukas, 2013. "Macro determinants of U.S. stock market risk premia in bull and bear markets," Hannover Economic Papers (HEP), Leibniz Universität Hannover, Wirtschaftswissenschaftliche Fakultät dp-520, Leibniz Universität Hannover, Wirtschaftswissenschaftliche Fakultät.
  15. repec:dgr:uvatin:2011093 is not listed on IDEAS

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