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Are Asset Returns Predictable from the National Accounts?

  • Pierre Lafourcade
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    Rational expectations and the logic of budget constraints imply that the predictability of asset returns hinges on the stability and persistence of households' ratio of saving to asset wealth, not of consumption to total wealth. This misalignment undermines the rationale for Lettau and Ludvigson's estimated cay, a stationary but unduly loose approximation to the true but non-mean-reverting cay. Definitional considerations on saving, assets and returns suggest rehabilitating money in the households'  flow of funds identity. Accounting for money balances in cay restores stationarity, but at the cost of drastically lower persistence and predictive potential. 

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    Paper provided by Netherlands Central Bank, Research Department in its series DNB Working Papers with number 189.

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    Date of creation: Dec 2008
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    Handle: RePEc:dnb:dnbwpp:189
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    1. Karl Whelan & Jeremy Rudd, 2006. "Empirical proxies for the consumption–wealth ratio," Open Access publications 10197/212, School of Economics, University College Dublin.
    2. Gonzalo, Jesus & Ng, Serena, 2001. "A systematic framework for analyzing the dynamic effects of permanent and transitory shocks," Journal of Economic Dynamics and Control, Elsevier, vol. 25(10), pages 1527-1546, October.
    3. 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.
    4. Hoffmann, Mathias, 2006. "Balanced Growth and Empirical Proxies of the Consumption-Wealth Ratio," Technical Reports 2006,26, Technische Universität Dortmund, Sonderforschungsbereich 475: Komplexitätsreduktion in multivariaten Datenstrukturen.
    5. Whelan, Karl, 2006. "Consumption and Expected Asset Returns Without Assumptions About Unobservables," Research Technical Papers 4/RT/06, Central Bank of Ireland.
    6. Michael G. Palumbo & Jeremy B. 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.).
    7. Sydney Ludvigson & Martin Lettau, 1999. "Consumption, aggregate wealth and expected stock returns," Staff Reports 77, Federal Reserve Bank of New York.
    8. Martin Lettau & Sydney Ludvigson, 2003. "Understanding Trend and Cycle in Asset Values: Reevaluating the Wealth Effect on Consumption," NBER Working Papers 9848, National Bureau of Economic Research, Inc.
    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.
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