Abstract
Lettau and Ludvigson [Lettau, M., Ludvigson, S.C., 2001a. Consumption, aggregate wealth and expected stock returns. Journal of Finance 56, 815-849] find that the estimated consumption-wealth ratio (cay) is a strong predictor of U.S. stock returns, while Brennan and Xia [Brennan, M.J., Xia, Y., 2005. tay's as good as cay. Finance Research Letters 2, 1-14] argue that the predictive power of cay arises from a look-ahead bias. In a unified framework, we examine how the presence of deterministic time trends affects the estimation and forecasting power of cay. We show that ignoring the presence of a deterministic time trend in estimating the cointegrating relationship among consumption, asset wealth, and labor income leads to a biased estimate of the consumption-wealth ratio. In the presence of a deterministic time trend, cay is a combination of the highly persistent bias component and the unbiased cointegrating residual, and most of the predictive power of cay is attributable to the bias component, casting doubt on the robustness of the forecasting power of cay.
| Original language | English |
|---|---|
| Pages (from-to) | 183-202 |
| Number of pages | 20 |
| Journal | Journal of Empirical Finance |
| Volume | 13 |
| Issue number | 2 |
| DOIs | |
| Publication status | Published - 2006 Mar 1 |
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All Science Journal Classification (ASJC) codes
- Finance
- Economics and Econometrics
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Interpreting the predictive power of the consumption-wealth ratio. / Hahn, Jaehoon; Lee, Hangyong.
In: Journal of Empirical Finance, Vol. 13, No. 2, 01.03.2006, p. 183-202.Research output: Contribution to journal › Article
TY - JOUR
T1 - Interpreting the predictive power of the consumption-wealth ratio
AU - Hahn, Jaehoon
AU - Lee, Hangyong
PY - 2006/3/1
Y1 - 2006/3/1
N2 - Lettau and Ludvigson [Lettau, M., Ludvigson, S.C., 2001a. Consumption, aggregate wealth and expected stock returns. Journal of Finance 56, 815-849] find that the estimated consumption-wealth ratio (cay) is a strong predictor of U.S. stock returns, while Brennan and Xia [Brennan, M.J., Xia, Y., 2005. tay's as good as cay. Finance Research Letters 2, 1-14] argue that the predictive power of cay arises from a look-ahead bias. In a unified framework, we examine how the presence of deterministic time trends affects the estimation and forecasting power of cay. We show that ignoring the presence of a deterministic time trend in estimating the cointegrating relationship among consumption, asset wealth, and labor income leads to a biased estimate of the consumption-wealth ratio. In the presence of a deterministic time trend, cay is a combination of the highly persistent bias component and the unbiased cointegrating residual, and most of the predictive power of cay is attributable to the bias component, casting doubt on the robustness of the forecasting power of cay.
AB - Lettau and Ludvigson [Lettau, M., Ludvigson, S.C., 2001a. Consumption, aggregate wealth and expected stock returns. Journal of Finance 56, 815-849] find that the estimated consumption-wealth ratio (cay) is a strong predictor of U.S. stock returns, while Brennan and Xia [Brennan, M.J., Xia, Y., 2005. tay's as good as cay. Finance Research Letters 2, 1-14] argue that the predictive power of cay arises from a look-ahead bias. In a unified framework, we examine how the presence of deterministic time trends affects the estimation and forecasting power of cay. We show that ignoring the presence of a deterministic time trend in estimating the cointegrating relationship among consumption, asset wealth, and labor income leads to a biased estimate of the consumption-wealth ratio. In the presence of a deterministic time trend, cay is a combination of the highly persistent bias component and the unbiased cointegrating residual, and most of the predictive power of cay is attributable to the bias component, casting doubt on the robustness of the forecasting power of cay.
UR - http://www.scopus.com/inward/record.url?scp=33344473049&partnerID=8YFLogxK
UR - http://www.scopus.com/inward/citedby.url?scp=33344473049&partnerID=8YFLogxK
U2 - 10.1016/j.jempfin.2005.09.002
DO - 10.1016/j.jempfin.2005.09.002
M3 - Article
VL - 13
SP - 183
EP - 202
JO - Journal of Empirical Finance
JF - Journal of Empirical Finance
SN - 0927-5398
IS - 2
ER -