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CONSUMPTION AND EXPECTED ASSET RETURNS: AN UNOBSERVED-COMPONENT APPROACH

Published online by Cambridge University Press:  02 January 2014

Narayan K. Kishor  and
Swati Kumari
Narayan K. Kishor*
Affiliation:
University of Wisconsin–Milwaukee
Swati Kumari
Affiliation:
University of Wisconsin–Milwaukee
*
Address correspondence to: N. Kundan Kishor, Department of Economics, Bolton Hall, Box 413, University of Wisconsin—Milwaukee, Milwaukee, WI 53201, USA; e-mail: kishor@uwm.edu.
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Abstract

This paper proposes an unobserved-component approach to estimate expected returns on household assets and expected growth rates of excess consumption (consumption in excess of labor income) within a present-value model of consumption. The present-value model of consumption implies that the excess-consumption–assets ratio can be expressed as a function of the present discounted value of expected excess-consumption growth rate and expected asset returns. Because expected returns and expected excess-consumption growth rate are unobserved variables, we use an unobserved-component approach to extract them from the observed history of realized returns and excess-consumption growth rate. Our results suggest that both filtered returns and filtered excess-consumption growth rate are significant and better predictors of realized returns and realized excess-consumption growth rate than the one obtained by the lagged excess-consumption–assets ratio.

Keywords

ConsumptionAsset ReturnsUnobserved-Component Model
Type
Articles
Information
Macroeconomic Dynamics , Volume 19 , Issue 5 , July 2015 , pp. 1023 - 1044
Copyright
Copyright © Cambridge University Press 2013 

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