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Stock returns and expected business conditions: Half a century of direct evidence

  • Campbell, Sean D.
  • Diebold, Francis X.

We explore the macro/finance interface in the context of equity markets. In particular, using half a century of Livingston expected business conditions data we characterize directly the impact of expected business conditions on expected excess stock returns. Expected business conditions consistently affect expected excess returns in a statistically and economically significant counter-cyclical fashion: depressed expected business conditions are associated with high expected excess returns. Moreover, inclusion of expected business conditions in otherwise standard predictive return regressions substantially reduces the explanatory power of the conventional financial predictors, including the dividend yield, default premium, and term premium, while simultaneously increasing R2. Expected business conditions retain predictive power even after controlling for an important and recently introduced non-financial predictor, the generalized consumption/wealth ratio, which accords with the view that expected business conditions play a role in asset pricing different from and complementary to that of the consumption/wealth ratio. We argue that time-varying expected business conditions likely capture time-varying risk, while time-varying consumption/wealth may capture time-varying risk aversion.

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Paper provided by Center for Financial Studies (CFS) in its series CFS Working Paper Series with number 2005/22.

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Date of creation: 2005
Date of revision:
Handle: RePEc:zbw:cfswop:200522
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  1. Miller, Edward M, 1977. "Risk, Uncertainty, and Divergence of Opinion," Journal of Finance, American Finance Association, vol. 32(4), pages 1151-68, September.
  2. John Y. Campbell & John Cochrane, 1999. "Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," Journal of Political Economy, University of Chicago Press, vol. 107(2), pages 205-251, April.
  3. Martin Lettau & Sydney Ludvigson, 1999. "Resurrecting the (C)CAPM: a cross-sectional test when risk premia are time-varying," Staff Reports 93, Federal Reserve Bank of New York.
  4. Leitch, Gordon & Tanner, J Ernest, 1991. "Economic Forecast Evaluation: Profits versus the Conventional Error Measures," American Economic Review, American Economic Association, vol. 81(3), pages 580-90, June.
  5. Christoffersen, Peter F. & Diebold, Francis X., 1997. "Optimal Prediction Under Asymmetric Loss," Econometric Theory, Cambridge University Press, vol. 13(06), pages 808-817, December.
  6. Constantinides,George & Duffie,Darrel, 1992. "Asset pricing with heterogeneous consumers," Discussion Paper Serie A 381, University of Bonn, Germany.
  7. Martin Lettau, 2001. "Consumption, Aggregate Wealth, and Expected Stock Returns," Journal of Finance, American Finance Association, vol. 56(3), pages 815-849, 06.
  8. Hamilton, James D & Gang, Lin, 1996. "Stock Market Volatility and the Business Cycle," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 11(5), pages 573-93, Sept.-Oct.
  9. John Y. Campbell & John H. Cochrane, 1995. "By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," NBER Working Papers 4995, National Bureau of Economic Research, Inc.
  10. Fama, Eugene F. & French, Kenneth R., 1989. "Business conditions and expected returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 25(1), pages 23-49, November.
  11. Schwert, G William, 1989. " Why Does Stock Market Volatility Change over Time?," Journal of Finance, American Finance Association, vol. 44(5), pages 1115-53, December.
  12. Hodrick, Robert J, 1992. "Dividend Yields and Expected Stock Returns: Alternative Procedures for Inference and Measurement," Review of Financial Studies, Society for Financial Studies, vol. 5(3), pages 357-86.
  13. Robert J. Shiller & John Y. Campbell, 1986. "The Dividend-Price Ratio and Expectations of Future Dividends and Discount Factors," Cowles Foundation Discussion Papers 812, Cowles Foundation for Research in Economics, Yale University.
  14. John H. Cochrane & Monika Piazzesi, 2002. "Bond Risk Premia," NBER Working Papers 9178, National Bureau of Economic Research, Inc.
  15. Torben G. Andersen & Tim Bollerslev & Francis X. Diebold & Jin (Ginger) Wu, 2005. "A Framework for Exploring the Macroeconomic Determinants of Systematic Risk," NBER Working Papers 11134, National Bureau of Economic Research, Inc.
  16. Barro, Robert J, 1990. "The Stock Market and Investment," Review of Financial Studies, Society for Financial Studies, vol. 3(1), pages 115-31.
  17. Fama, Eugene F, 1990. " Stock Returns, Expected Returns, and Real Activity," Journal of Finance, American Finance Association, vol. 45(4), pages 1089-1108, September.
  18. Gultekin, N Bulent, 1983. " Stock Market Returns and Inflation Forecasts," Journal of Finance, American Finance Association, vol. 38(3), pages 663-73, June.
  19. Fama, Eugene F. & French, Kenneth R., 1988. "Dividend yields and expected stock returns," Journal of Financial Economics, Elsevier, vol. 22(1), pages 3-25, October.
  20. Chen, Nai-Fu & Roll, Richard & Ross, Stephen A, 1986. "Economic Forces and the Stock Market," The Journal of Business, University of Chicago Press, vol. 59(3), pages 383-403, July.
  21. Ferson, Wayne E & Harvey, Campbell R, 1991. "The Variation of Economic Risk Premiums," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 385-415, April.
  22. Campbell, John, 1991. "A Variance Decomposition for Stock Returns," Scholarly Articles 3207695, Harvard University Department of Economics.
  23. Dean Croushore, 1997. "The Livingston Survey: still useful after all these years," Business Review, Federal Reserve Bank of Philadelphia, issue Mar, pages 15-27.
  24. Guo, Hui & Savickas, Robert, 2006. "Idiosyncratic Volatility, Stock Market Volatility, and Expected Stock Returns," Journal of Business & Economic Statistics, American Statistical Association, vol. 24, pages 43-56, January.
  25. repec:cup:etheor:v:13:y:1997:i:6:p:808-17 is not listed on IDEAS
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