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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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Cited by:
  1. Pakoš, Michal, 2013. "Long-run risk and hidden growth persistence," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 37(9), pages 1911-1928.
  2. Marc Joëts, 2012. "Energy price transmissions during extreme movements," EconomiX Working Papers 2012-38, University of Paris West - Nanterre la Défense, EconomiX.
  3. 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.
  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:dgr:uvatin:2010115 is not listed on IDEAS
  6. repec:dgr:uvatin:2011093 is not listed on IDEAS
  7. 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.
  8. repec:ipg:wpaper:28 is not listed on IDEAS
  9. Mordecai Kurz & Maurizio Motolese, 2011. "Diverse beliefs and time variability of risk premia," Economic Theory, Springer, Springer, vol. 47(2), pages 293-335, June.
  10. 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.
  11. 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.
  12. Conrad, Christian & Loch, Karin, 2012. "Anticipating Long-Term Stock Market Volatility," Working Papers 0535, University of Heidelberg, Department of Economics.
  13. 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.
  14. Nuno Silva, 2013. "Equity Premia Predictability in the EuroZone," GEMF Working Papers 2013-22, GEMF - Faculdade de Economia, Universidade de Coimbra.
  15. Torben G. Andersen & Tim Bollerslev & Peter F. Christoffersen & Francis X. Diebold, 2011. "Financial Risk Measurement for Financial Risk Management," CREATES Research Papers 2011-37, School of Economics and Management, University of Aarhus.

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