Consumer expectations and short-horizon return predictability

Egon Kalotay*, Philip Gray, Samantha Sin

*Corresponding author for this work

Research output: Contribution to journalArticle

7 Citations (Scopus)

Abstract

Lettau and Ludvigson [Lettau, M., Ludvigson, S, 2001. Consumption, aggregate wealth and expected stock returns. Journal of Finance 56, 815-849] argue that fluctuations from the equilibrium ratio of consumption to wealth (cây) reflect changing expectations of asset returns and document significant short-horizon predictability based on cây. This paper further explores the role of consumer expectations in modeling time variation of expected equity returns by considering two measures of consumer expectations: (i) consumer behavior as reflected in cây, and (ii) a more-direct measure of expectations captured by the Index of Consumer Sentiment (ICS). We report strong regression-based evidence of return predictability based on cây, which remains evident even after accounting for various sources of estimation risk. However, the regression-based evidence of predictability does not necessarily imply that shifts in aggregate consumption and the components of aggregate wealth give rise to economically significant investment signals. The survey-based measure of expectations (ICS) is shown to complement the behavioral measure (cây) but has no apparent stand-alone predictive value in forecasting equity returns.

Original languageEnglish
Pages (from-to)3102-3124
Number of pages23
JournalJournal of Banking and Finance
Volume31
Issue number10
DOIs
Publication statusPublished - Oct 2007

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