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Friday, November 11, 2005

Stock Returns and Expected Business Conditions

I haven't had chance to read this closely yet, but it looks like a paper worth passing along as it connects expected business conditions to excess stock returns, shows that expected business conditions are linked to standard predictors of excess returns, amd reinforces recent evidence that expected returns are countercyclical:

Stock Returns and Expected Business Conditions: Half a Century of Direct Evidence, by Sean D. Campbell, Francis X. Diebold, NBER WP 11736, November 2005: Abstract ...[U]sing 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 R-squared. Expected business conditions retain predictive power even after controlling for ... 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. [Free versions here and here.]

    Posted by on Friday, November 11, 2005 at 09:27 AM in Academic Papers, Economics | Permalink  TrackBack (0)  Comments (1)

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