Consumption, asset wealth, equity premium, term spread, and flight to quality

Abstract

We link transitory deviations of consumption from its equilibrium relationship with aggregate wealth and labor income to equity returns on the one hand, and to two characteristics of bond investors-the premium demanded to hold long-term assets, and "flight to quality" behavior-on the other hand. Using a panel of 10 euro area countries over the period 1984Q1-2017Q4, we show that a rise in the consumption-wealth ratio predicts both higher equity returns and the future term spread, while a fall in the consumption-wealth ratio explains a large fraction of the rise in the spread between the "risky" and the "safe-haven" bond.

Does inequality help in forecasting equity premium in a panel of G7 countries?

“…Forecasting stock returns and/or equity premium -which has been in the centre of several studies using both time series and panel data-based approaches (see for example, Rapach et al, (2005, Sousa (2010), Sousa (2011), Sousa (2015aSousa ( , 2015b, Afonso and Sousa (2011), Sousa (2012), Rocha Armada et al (2015, Caporale and Sousa (2016), Sousa et al, (2016), De Castro andIssler (2016), Aye et al, (2017), Costantini and Sousa (2020)) -is an interesting question for at least two reasons. First, practitioners in finance require real-time forecasts of stock returns for asset allocation.…”