Labor Income and Predictable Stock Returns
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Predictability, both in the time series and the cross section of stock returns, has been the focus of much research in the field of empirical finance. At the time-series level, the main finding is that variables like the price-dividend ratio and term premia can predict stock returns variation at long horizons.1 As for the cross section of stock returns, predictability translates into the use of conditioning variables to improve on the performance of the CAPM and Consumption CAPM (CCAPM) versus their unconditional counterparts. These two strands of the literature connect because lagged instruments that are shown to predict market returns are natural conditioning variables for tests of the cross section.
Extant economic explanations for the time-series and cross-sectional predictability are notably sparse and detached from one another. Time series predictability is obtained by either investors’ learning about some unobservable fundamental process as in Timmermann (1993, 1996) and Veronesi (2000) or cyclical variations in investors’ risk aversion as in Campbell and Cochrane (1999) and Barberis et al. (2001). Instead, at the cross-sectional level, the theoretical models concentrate either on portfolio constraints (Cuoco (1997)) or the exploitation of growth options’ opportunities (Gomes et al. (2000)). A notable exception is Berk et al. (1999) who construct a model of firm’s investment with implications for the cross section and that yields interest rates as predictors of market returns. Download free Labor Income and Predictable Stock Returns.pdf here
Extant economic explanations for the time-series and cross-sectional predictability are notably sparse and detached from one another. Time series predictability is obtained by either investors’ learning about some unobservable fundamental process as in Timmermann (1993, 1996) and Veronesi (2000) or cyclical variations in investors’ risk aversion as in Campbell and Cochrane (1999) and Barberis et al. (2001). Instead, at the cross-sectional level, the theoretical models concentrate either on portfolio constraints (Cuoco (1997)) or the exploitation of growth options’ opportunities (Gomes et al. (2000)). A notable exception is Berk et al. (1999) who construct a model of firm’s investment with implications for the cross section and that yields interest rates as predictors of market returns. Download free Labor Income and Predictable Stock Returns.pdf here
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