Consumption, aggregate wealth and expected stock returns: a fractional cointegration approach

Abstract

Lettau and Ludvigson [J. Finance, 2001a, 56(3), 815–849] demonstrated that cay, the transitory deviation from the common trend in consumption, asset wealth and human capital, has strong predictive power for real stock returns. We propose using a more general fractional cointegration structure to estimate this transitory deviation, denoted as . The empirical analysis shows that has better in-sample and out-of-sample predictive power than cay.