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

  • Campbell, Sean D.
  • Diebold, Francis X.

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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Article provided by American Statistical Association in its journal Journal of Business and Economic Statistics.

Volume (Year): 27 (2009)
Issue (Month): 2 ()
Pages: 266-278

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Handle: RePEc:bes:jnlbes:v:27:i:2:y:2009:p:266-278
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  13. Dean Croushore, 1997. "The Livingston Survey: still useful after all these years," Business Review, Federal Reserve Bank of Philadelphia, issue Mar, pages 15-27.
  14. Robert J. Barro, 1989. "The Stock Market and Investment," NBER Working Papers 2925, National Bureau of Economic Research, Inc.
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  19. Leitch, Gordon & Tanner, J Ernest, 1991. "Economic Forecast Evaluation: Profits versus the Conventional Error Measures," American Economic Review, American Economic Association, vol. 81(3), pages 580-90, June.
  20. Hui Guo & Robert Savickas, 2005. "Idiosyncratic volatility, stock market volatility, and expected stock returns," Working Papers 2003-028, Federal Reserve Bank of St. Louis.
  21. Miller, Edward M, 1977. "Risk, Uncertainty, and Divergence of Opinion," Journal of Finance, American Finance Association, vol. 32(4), pages 1151-68, September.
  22. Ferson, Wayne E & Harvey, Campbell R, 1991. "The Variation of Economic Risk Premiums," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 385-415, April.
  23. 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, vol. 107(2), pages 205-251, April.
  24. John H. Cochrane & Monika Piazzesi, 2005. "Bond Risk Premia," American Economic Review, American Economic Association, vol. 95(1), pages 138-160, March.
  25. Chen, Nai-Fu & Roll, Richard & Ross, Stephen A, 1986. "Economic Forces and the Stock Market," The Journal of Business, University of Chicago Press, vol. 59(3), pages 383-403, July.
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