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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 Frank Diebold & Sean Campbell, 2005. "Stock returns and expected business conditions: half a century of direct evidence," Proceedings, Board of Governors of the Federal Reserve System (U.S.).
Handle: RePEc:nbr:nberwo:11736

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References

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Citations

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Cited by:
  1. 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.
  2. Paye, Bradley S., 2012. "‘Déjà vol’: Predictive regressions for aggregate stock market volatility using macroeconomic variables," Journal of Financial Economics, Elsevier, vol. 106(3), pages 527-546.
  3. Marc Joëts, 2012. "Energy price transmissions during extreme movements," EconomiX Working Papers 2012-38, University of Paris West - Nanterre la Défense, EconomiX.
  4. repec:dgr:uvatin:2010115 is not listed on IDEAS
  5. 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.
  6. Christian Pierdzioch & Stefan Reitz & Jan-Christoph Ruelke, 2014. "Heterogeneous Forecasters and Nonlinear Expectation Formation in the U.S. Stock Market," Kiel Working Papers 1947, Kiel Institute for the World Economy.
  7. repec:ipg:wpaper:28 is not listed on IDEAS
  8. Baetje, Fabian & Menkhoff, Lukas, 2013. "Macro determinants of U.S. stock market risk premia in bull and bear markets," Hannover Economic Papers (HEP) dp-520, Leibniz Universität Hannover, Wirtschaftswissenschaftliche Fakultät.
  9. 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.
  10. Pakos, Michal, 2013. "Long-Run Risk and Hidden Growth Persistence," MPRA Paper 47217, University Library of Munich, Germany.
  11. Nuno Silva, 2013. "Equity Premia Predictability in the EuroZone," GEMF Working Papers 2013-22, GEMF - Faculdade de Economia, Universidade de Coimbra.
  12. van den Hauwe, Sjoerd & Paap, Richard & van Dijk, Dick, 2013. "Bayesian forecasting of federal funds target rate decisions," Journal of Macroeconomics, Elsevier, vol. 37(C), pages 19-40.
  13. M. Barari & Brian Lucey & S. Voronkova, 2008. "Reassessing co-movements among G7 equity markets: evidence from iShares," Applied Financial Economics, Taylor & Francis Journals, vol. 18(11), pages 863-877.
  14. Fong, Wai Mun, 2012. "Do expected business conditions explain the value premium?," Journal of Financial Markets, Elsevier, vol. 15(2), pages 181-206.
  15. repec:dgr:uvatin:2011093 is not listed on IDEAS
  16. Anjeza Kadilli, 2014. "Return Predictability in International Financial Markets and the Role of Investor Sentiment," Research Papers by the Institute of Economics and Econometrics, Geneva School of Economics and Management, University of Geneva 14083, Institut d'Economie et Econométrie, Université de Genève.
  17. Conrad, Christian & Loch, Karin, 2012. "Anticipating Long-Term Stock Market Volatility," Working Papers 0535, University of Heidelberg, Department of Economics.

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