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Consumption and Expected Asset Returns Without Assumptions About Unobservables

  • Whelan, Karl

    (Central Bank and Financial Services Authority of Ireland)

If asset returns are predictable, then rational expectations and the arithmetic of budget constraints together imply that these predictable changes in returns should affect current consumption. This paper presents a new framework linking consumption, income, and observable assets to expectations of future asset returns. Relative to previous work on this topic, the framework proposed in this paper has a number of advantages including not relying on untestable assumptions concerning unobservable variables and not requiring estimation of unknown parameters to arrive at a forecasting variable.

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File URL: http://www.centralbank.ie/publications/Documents/4RT06.pdf
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Paper provided by Central Bank of Ireland in its series Research Technical Papers with number 4/RT/06.

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Length: 29 pages
Date of creation: May 2006
Date of revision:
Handle: RePEc:cbi:wpaper:4/rt/06
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  1. Stock, James H & Watson, Mark W, 1993. "A Simple Estimator of Cointegrating Vectors in Higher Order Integrated Systems," Econometrica, Econometric Society, vol. 61(4), pages 783-820, July.
  2. Pierre-Olivier Gourinchas & Hélène Rey, 2005. "International financial adjustment," Proceedings, Federal Reserve Bank of San Francisco.
  3. John Y. Campbell, 1990. "A Variance Decomposition for Stock Returns," NBER Working Papers 3246, National Bureau of Economic Research, Inc.
  4. John H. Cochrane, 2008. "The Dog That Did Not Bark: A Defense of Return Predictability," Review of Financial Studies, Society for Financial Studies, vol. 21(4), pages 1533-1575, July.
  5. Michael Palumbo & Jeremy Rudd & Karl Whelan, 2002. "On the relationships between real consumption, income and wealth," Finance and Economics Discussion Series 2002-38, Board of Governors of the Federal Reserve System (U.S.).
  6. Campbell, John, 1993. "Intertemporal Asset Pricing Without Consumption Data," Scholarly Articles 3221491, Harvard University Department of Economics.
  7. Stambaugh, Robert F., 1999. "Predictive regressions," Journal of Financial Economics, Elsevier, vol. 54(3), pages 375-421, December.
  8. Lettau, Martin & Ludvigson, Sydney C., 2005. "tay's as good as cay: Reply," Finance Research Letters, Elsevier, vol. 2(1), pages 15-22, March.
  9. John Y. Campbell & N. Gregory Mankiw, 1989. "Consumption, Income, and Interest Rates: Reinterpreting the Time Series Evidence," NBER Working Papers 2924, National Bureau of Economic Research, Inc.
  10. Sydney Ludvigson & Martin Lettau, 1999. "Consumption, aggregate wealth and expected stock returns," Staff Reports 77, Federal Reserve Bank of New York.
  11. Brennan, Michael J. & Xia, Yihong, 2005. "tay's as good as cay," Finance Research Letters, Elsevier, vol. 2(1), pages 1-14, March.
  12. repec:fth:harver:1435 is not listed on IDEAS
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