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Fiscal Imbalances and Asset Returns: Cross-Sector Fluctuations under the Aggregate Budget Constraint

Author

Listed:
  • Junxiong Gao

    (Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF))

  • Alberto Plazzi

    (Universita' della Svizzera italiana; Swiss Finance Institute)

  • Rossen I. Valkanov

    (University of California, San Diego (UCSD) - Rady School of Management)

  • Yan Xu

    (HKU, Faculty of Business and Economics)

Abstract

We embed the budget constraints of the private, public, and external sectors within the aggregate budget constraint of the economy to examine whether valuation ratios in one sector forecast real returns and cash-flow growth in others. Exploiting the cross-sector restrictions implied by the aggregate constraint, we show that fluctuations in the government surplus-to-debt ratio robustly predict equity returns. The magnitude of this cross-sector predictability is on par with the ownsector predictability associated with the dividend-price ratio. We then develop a model in which distortionary taxes generate these patterns and use the cross-sector forecasts to calibrate the implied size of the tax distortions.

Suggested Citation

  • Junxiong Gao & Alberto Plazzi & Rossen I. Valkanov & Yan Xu, 2025. "Fiscal Imbalances and Asset Returns: Cross-Sector Fluctuations under the Aggregate Budget Constraint," Swiss Finance Institute Research Paper Series 25-102, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp25102
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    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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