Aggregate Asset Growth and Expected Stock Returns

Abstract

This paper suggests a novel approach for predicting aggregate stock returns at quarterly and annual frequencies. Weak return predictability of macroeconomic and financial variables is consistent with the view that expected returns are time-varying and highly persistent. Taking a first difference of returns nearly cancels out expected returns. A variable that is correlated with innovations in expected returns can be used to forecast changes in returns. Using aggregate asset growth (growth of household net worth) as a predictive variable delivers better out-of-sample forecasts for aggregate stock returns compared to other predictors, suggesting that the variable contains information regarding these innovations.