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Business Cycles, Regime Shifts, and Return Predictability

Published online by Cambridge University Press:  10 March 2023

Wei Yang Open the ORCID record for Wei Yang [Opens in a new window]
Wei Yang*
Affiliation:
William & Mary Mason School of Business
*
wei.yang@mason.wm.edu
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Abstract

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Consistent with the empirical properties of the consumption data, I develop a model in which consumption and dividend growth follow regime-switching dynamics. I show that regime-shift risk is priced in the model. Regime-shift risk exhibits dominant influence on asset prices: It generates a high equity premium and also induces time-varying risk premiums. The model explains major business cycle-dependent asset market phenomena and, in particular, the stronger predictability of stock returns during recessions.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 58 , Issue 7 , November 2023 , pp. 3058 - 3084
Copyright
© The Author(s), 2023. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

Footnotes

I am grateful for the helpful comments from an anonymous referee, Ravi Bansal, Geert Bekaert, John Cochrane, Paul Malatesta (the editor), Boris Nikolov, Robert Ready, Toni Whited, Amir Yaron, and seminar participants at the Penn State University, University of Minnesota, University of Texas at Dallas, Hong Kong University of Science and Technology, SUNY Buffalo, and Indiana University Bloomington. Special thanks to Ken Singleton for many valuable suggestions.

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