The Wealth-Consumption Ratio (original) (raw)

The wealth-consumption ratio: A litmus test for consumption-based asset pricing models

2007

We propose a new method to measure the wealth-consumption ratio. We estimate an exponentially affine model of the stochastic discount factor on bond yields and stock returns and use that discount factor to compute the no-arbitrage price of a claim to aggregate US consumption. We find that total wealth is much safer than stock market wealth. The consumption risk premium is only 2.2%, substantially below the equity risk premium of 6.9%. As a result, our estimate of the wealth-consumption ratio is much higher than the price-dividend ratio on stocks throughout the postwar period. The high wealth-consumption ratio implies that the average US household has a lot of wealth, most of it human wealth. The wealthconsumption ratio also has lower volatility than the price-dividend ratio on equity. A variance decomposition of the wealth-consumption ratio shows that future returns account for most of its variation. The predictability is mostly for future interest rates, not future excess returns. We conclude that the properties of total wealth are more similar to those of a long-maturity bond portfolio than those of a stock portfolio. Many dynamic asset pricing models require total wealth returns as inputs, but equity returns are commonly used as a proxy. The differences we find between the risk-return characteristics of equity and total wealth suggest that equity is special.

Consumption, Wealth, Stock and Government Bond Returns: International Evidence*

The Manchester School, 2011

In this paper, we show, from the consumer's budget constraint, that the residuals of the trend relationship among consumption, aggregate wealth, and labour income should predict both stock returns and government bond yields. We use data for several OECD countries and find that when agents expect future stock returns to be higher, they will temporarily allow consumption to rise. Regarding government bond yields, when bonds are seen as a component of asset wealth, then investors react in the same way. If, however, the increase in the yields is perceived as signalling a future rise in taxes, then they will temporarily reduce their consumption.

Consumption Risk and the Cross-Section of Government Bond Returns

SSRN Electronic Journal, 2011

We use a consumption-based asset pricing model with Epstein-Zin-Weil recursive preferences to explain the cross-section of excess returns on nominal US Treasury bond portfolios. Our model has two pricing factors: innovations to current consumption growth and innovations to expected future consumption growth. We find, over the period 1975-2006, that nominal government bonds are, on average, risky assets as they pay off in good times characterized by good prospects for future consumption growth. The model explains well the cross-sectional variation in mean excess bond returns and provides reasonable estimates of structural parameters. Our results are robust to using alternate test assets, different definitions of consumption and estimation methods.

Investment portfolios and human wealth

1995

The optimal proportion of a household's investment portfolio that should be in risky assets such as stocks depends on what proportion of total wealth, including human wealth, the investment portfolio represents. This article estimates the total wealth of households in the U.S. Survey of Consumer Finances, and finds that financial assets represent less than 2% of the total wealth of most households. Only the elderly are likely to have investment portfolios representing a high proportion of total wealth.

Consumption, Wealth, the Elasticity of Intertemporal Substitution and Long-Run Stock Market Returns

SSRN Electronic Journal, 2005

The elasticity of intertemporal substitution is a parameter of crucial importance for macroeconomic policy. The available macroeconomic evidence on the value of this parameter for the US is conflicting. Calibrated dynamic models require a value close to one of the EIS to match the data, while estimated Euler equations concentrating on high frequency fluctuations in consumption deliver much lower values not significantly different from zero. Some recent empirical evidence indicates that the well-known asset pricing puzzles might be solved by considering consumption in the long-run. We extend these results to obtain an empirical estimate of the EIS consistent with that used in calibrated models.

Mutual funds and the evolving long-run effects of stock wealth on U.S. consumption

Journal of Economics and Business, 2006

Lower mutual fund loads have plausibly boosted the stock wealth elasticity of U.S. consumption by enhancing stock liquidity and arguably by inducing stock ownership among middle-income families, consistent with theory and cross-section data (Guiso, Haliassios, and Jappelli (2003), Haliassios (2002), Heaton and Lucas (1996, 2000), and Vissing-Jorgensen (2002)). In load-modified models, the stock wealth elasticity is declining in loads and more stable long-run wealth and income coefficients arise, especially controlling for mortgage refinancing and equity withdrawal activity. Modified models imply that the stock wealth elasticity has risen, while conventional models overestimate the wealth and underestimate the income elasticities of consumption.

The Consumption/Wealth and Book/Market Ratios in a Dynamic Asset Pricing Contex

Spanish Economic Review, 2006

This paper addresses new insights into the predictability of financial returns. In particular, we analyze two aspects of the controversial forecasting literature. On the one hand, we demonstrate a positive and contemporaneous link between aggregate book/market and consumption/wealth ratios. On the other hand, we show that real estate and human capital, as the present value of all future salaries, are key components of the consumption/wealth ratio in Spain. Specifically, we find that the cointegrating residuals of consumption, asset holdings, real estate holdings, and our measure of human capital provide a better forecast of future returns than does the standard proxy of the consumption/wealth ratio. This result is important because it clarifies the importance of country-specific components of wealth for cases in which the consumption/wealth ratio is employed as an instrument in conditional asset pricing models. Keywords Stock markets • Predictability • Consumption • Aggregate wealth • Book/market * Financial support from the Ministerio de Ciencia y Tecnología grant SEJ2005-09372 is gratefully acknowledged. * * Financial support from the Ministerio de Ciencia y Tecnología grant SEC2003-06457 is gratefully acknowledged.

Consumption Strikes Back? Measuring Long-Run Risk

Journal of Political Economy, 2008

We characterize and measure a long-run risk return tradeoff for the valuation of financial cash flows that are exposed to fluctuations in macroeconomic growth. This tradeoff features components of financial cash flows that are only realized far into the future but are still reflected in current asset values. We use the recursive utility model with empirical inputs from vector autoregressions to quantify this relationship; and we study the long-run risk differences in aggregate securities and in portfolios constructed based on the ration of book equity to market equity. Finally, we explore the resulting measurement challenges and the implied sensitivity to alternative specifications of stochastic growth.

Consumption growth, preference for smoothing, changes in expectations and risk premium

The Quarterly Review of Economics and Finance, 2015

This paper derives a relationship between consumption growth, the consumption-wealth ratio and its first-difference, and asset returns. Using quarterly data for sixteen OECD countries, we find that the three-factor asset pricing model explains a large fraction of the variation in real stock returns. The model captures: (i) the concerns of agents with states of the world in which consumption growth is low; (ii) the preference of investors for a smooth consumption path as implied by the intertemporal budget constraint; and (ii) the role played by shifts in expectations about future returns due to positive or negative news about their wealth.