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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. Campbell, John Y, 1991. "A Variance Decomposition for Stock Returns," Economic Journal, Royal Economic Society, vol. 101(405), pages 157-79, March.
  2. Karl Whelan & Michael Palumbo & Jeremy Rudd, 2002. "On the relationships between real consumption, income, and wealth," Open Access publications 10197/241, School of Economics, University College Dublin.
  3. Campbell, John Y, 1993. "Intertemporal Asset Pricing without Consumption Data," American Economic Review, American Economic Association, vol. 83(3), pages 487-512, June.
  4. Pierre-Olivier Gourinchas & Hélène Rey, 2007. "International Financial Adjustment," Journal of Political Economy, University of Chicago Press, vol. 115(4), pages 665-703, 08.
  5. Stambaugh, Robert F., 1999. "Predictive regressions," Journal of Financial Economics, Elsevier, vol. 54(3), pages 375-421, December.
  6. repec:fth:harver:1435 is not listed on IDEAS
  7. James H. Stock & Mark W. Watson, 1991. "A simple estimator of cointegrating vectors in higher order integrated systems," Working Paper Series, Macroeconomic Issues 91-3, Federal Reserve Bank of Chicago.
  8. Brennan, Michael J. & Xia, Yihong, 2005. "tay's as good as cay," Finance Research Letters, Elsevier, vol. 2(1), pages 1-14, March.
  9. John H. Cochrane, 2006. "The Dog That Did Not Bark: A Defense of Return Predictability," NBER Working Papers 12026, 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. Lettau, Martin & Ludvigson, Sydney C., 2005. "tay's as good as cay: Reply," Finance Research Letters, Elsevier, vol. 2(1), pages 15-22, March.
  12. 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.
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