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Business-cycle pattern of asset returns: a general equilibrium explanation

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  • Qiang Kang

    (Florida International University)

Abstract

I develop an analytical general-equilibrium model to explain economic sources of business-cycle pattern of aggregate stock market returns. With concave production functions and capital accumulation, a technology shock has a pro-cyclical direct effect and a counter-cyclical indirect effect on expected returns. The indirect effect, reflecting the “feedback” effect of consumers’ behavior on asset returns, dominates the direct effect and causes counter-cyclical variations of expected returns. I show that the conditional mean, volatility, and Sharpe ratios of asset returns all vary counter-cyclically and they are persistent and predictable, and that stock market behavior has forecasting power for real economic activity.

Suggested Citation

  • Qiang Kang, 2019. "Business-cycle pattern of asset returns: a general equilibrium explanation," Annals of Finance, Springer, vol. 15(4), pages 539-561, December.
    • Handle: RePEc:kap:annfin:v:15:y:2019:i:4:d:10.1007_s10436-019-00347-y
    DOI: 10.1007/s10436-019-00347-y
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    More about this item

    Keywords

    Counter-cyclical variation; Capital accumulation; Decreasing returns to capital; Overlapping-generation model;
    All these keywords.

    JEL classification:

    • D51 - Microeconomics - - General Equilibrium and Disequilibrium - - - Exchange and Production Economies
    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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