Asset Returns Under Model Uncertainty: Eveidence from the euro area, the U.K and the U.S

The goal of thes paper is to analyze predictability of future asset returns in the context of model uncertainty. Using data for the euro area, the US and the U.K., we show that one can improve the forecasts of stock returns using a Bayesian Model Averaging (BMA) approach, and there is a large amount of model uncertainty. The empirical evidence for the euro area suggests that several macroeconomic, financial and macro-financial variables are consistently among the most prominent determinants of risk premium. As for the U.S, only a few number of predictors play an important role. In the case of the UK, future stock returns are better forecasted by financial variables. These results are corroborated for both the M-open and the M-closed perspectives and in the context of "in-sample" and "out-of-sample" forescating. Finally, we highlight that the predictive ability of the BMA framework is stronger at longer periods, and clearly outperforms the constant expected returns and the autoregressive benchmark models.stock returns, model uncertainty, Bayesian Model Averaging

Wealth, Labour Income, Stock Returns and Government Bond Yields, and Financial Stress in the Euro Area

I show that when the ratio of asset wealth to human wealth falls, investors become more exposed to idiosyncratic shocks and demand higher stock and government bond risk premia. I find that the residuals from the cointegrating vector among asset wealth and labour income, wy, predict both future stock and bond returns in the Euro Area. Consequently, it can be used to track time-variation in risk premium. The results are robust to the inclusion of control variables and vis-a-vis other benchmark models. Finally, I show that, conditioning the predictive ability of wy on the financial stress conditions allows one to track better future time-variation in risk premium. Moreover, when financial stress increases, investors perceive a larger risk for both stocks and government bonds.wealth, income, stock returns, government bond yields

Expectations, Shocks, and Asset Returns

I use the consumer’s budget constraint to derive a relationship between stock market returns, the residuals of the trend relationship among consumption, aggregate wealth, and labour income, cay, and three major sources of risk: future changes in the housing consumption share, cr, future labour income growth, lr, and future consumption growth, lrc. Using a VAR, I compute measures of expected and unexpected long-run changes of the major determinants of asset returns and find that: (i) cay, cday, expected lr, cr, lrc and expected long-run changes in ex-ante real returns, lrret, strongly forecast future asset returns; (ii) unexpected lrc and unexpected lrret contain some predictive power for asset returns; (iii) unexpected lr and unexpected cr do not predict future asset returns. One can, therefore, use the intertemporal budget constraint and the forecasting properties of an informative VAR to generate the predictability of many economically motivated variables developed in the literature on asset pricing. The framework presented is sufficiently flexible to accommodate the implications of a wide class of optimal models of consumer behaviour without imposing a functional form on preferences.expectations, shocks, asset returns, wealth, income, consumption, housing share.

Collateralizable Wealth, Asset Returns, and Systemic Risk: International Evidence

I assess the role of wealth and systemic risk in explaining future asset returns. I show that the residuals of the trend relationship among asset wealth and human wealth predict both stock returns and government bond yields. Using data for a set of industrialized countries, I find that when the wealth-to-income ratio falls, investors demand a higher risk premium for stocks. As for government bond returns: (i) when they are seen as a component of asset wealth, investors react in the same manner; (ii) if, however, investors perceive the increase in government bond returns as signalling a future rise in taxes or a deterioration of public finances, then investors interpret the fall in the wealth-to-income ratio as a fall in future bond premia. Finally, I show that the occurrence of crises episodes (in particular, systemic crises) amplifies the transmission of housing market shocks to financial markets and the banking sector.stock returns; government bond yields; systemic crises.

How do Consumption and Asset Returns React to Wealth Shocks? Evidence from the U.S. and the U.K

In this work, I analyze the response of consumption and asset returns to unexpected wealth variation. Using data at quarterly frequency for the U.S. and the U.K., I show that: (i) while housing wealth shocks have a very persistent effect on consumption, financial wealth shocks only have transitory effects; and (ii) similarly, unexpected variation in housing wealth delivers a reasonably persistent response of real returns while financial wealth shocks have just a temporary effect.financial wealth, housing wealth, consumption, asset returns.

Wealth Effetcs on Consumption: Evidence from the euro area

This paper estimates the wealth effects on consumption in the euro area as a whole. I show that: (i) financial wealth effects are relatively large and statistically significant; (ii) housing wealth effects are virtually nil and not significant; (iii) consumption growth exhibits strong persistence and responds sluggishly to shocks; and (iv) the immediate response of consumption to wealth is substantially different from the long-run wealth effects. By disaggregating financial wealth into its major components, the estimates suggest that wealth effects are particularly large for currency and deposits, and shares and mutual funds. In addition, consumption seems to be very responsive to financial liabilities and mortage loans.Consumption, Housing Wealth, Financial Wealth.

The consumption-wealth ratio and asset returns: The Euro Area, the UK and the US

In this paper, I assess the forecasting power of the residuals of the trend relationship among consumption, aggregate wealth, and labour income for stock returns and government bond yields in the euro area, the UK and the US . I find that when stock returns are expected to be higher in the future, forward-looking investors will temporarily allow consumption to rise. As for bond returns, when government bonds are seen as a component of asset wealth, then investors react in the same manner. If, however, investors perceive the increase in bond returns as signalling a future rise in taxes or a deterioration of public finances, then they will let consumption fall temporarily below its equilibrium level.consumption, wealth, stock returns, bond returns.

Consumption, (Dis) Aggregate Wealth and Asset Returns

In this work, we analyse the importance of disaggregation of wealth into main components (financial and housing wealth). We show, from the consumer´s intertemporal budget constraint, that the residuals of the trend relationship among consumption, financial wealth, housing wealth and labor income (summarized by the variable cday) should help to predict U.K quarterly asset returns, and to provide better forecasts than a variable like cay from Lettan and Ludvigson (2001), which considers aggregate wealth instead. Using a sample for the U.K. for the period 1975:Q1 - 2003:Q4, we also find that: (i) financial wealth effects are significantly different from housing wealth efects; (ii) changes in financial wealth are mainly transitory, while changes in housing wealth are better understood as permanent; (iii) the relationship among consumption, (dis)aggregate wealth and labor income was relatively stable over time; (iv) consumption doesn´t react asymmetrically to positive and negative financial (or housing) wealth shocks.financial wealth, housing wealth, consumption, expected returns.

The Macroeconomic Effects of Fiscal Policy in Portugal: a Bayesian SVAR Analysis

In the last twenty years Portugal struggled to keep public finances under control, notably in containing primary spending. We use a new quarterly dataset covering 1979:1-2007:4, and estimate a Bayesian Structural Autoregression model to analyze the macroeconomic effects of fiscal policy. The results show that positive government spending shocks, in general, have a negative effect on real GDP; lead to important “crowding-out” effects, by impacting negatively on private consumption and investment; and have a persistent and positive effect on the price level and the average cost of financing government debt. Positive government revenue shocks tend to have a negative impact on GDP; and lead to a fall in the price level. The evidence also shows the importance of explicitly considering the government debt dynamics in the model. Finally, a VAR counter-factual exercise confirms that unexpected positive government spending shocks lead to important “crowding-out” effects..B-SVAR, fiscal policy, debt dynamics, Portugal.

Assessing Long-Term Fiscal Developments: Evidence from Portugal

Drawing on quarterly data for Portugal, we use a Three-Stage Least Square method and a system of equations to recursively estimate two components of fiscal policy – responsiveness and persistence – and to infer about the sources of fiscal deterioration (improvement). The results suggest that: (i) government spending exhibits higher persistence than government revenue; and (ii) government revenue is more responsive to the business cycle than government spending.Fiscal deterioration; Portugal.