Cyclical Consumption and Time-Variation in Expected Stock Returns

Abstract

This paper introduces a new consumption-based predictive variable, cyclical consumption, that captures time-variation in expected stock returns. Predictive regressions provide evidence of a strong negative relation between cyclical consumption and future excess stocks returns, implying that expected stock returns are high when cyclical consumption is low in ecconomic contractions. Cyclical consumption contains relevant information about expected stock returns not already embedded in existing consumption-based predictive variables such as the consumption-wealth ratio and strongly outperforms financial predictive variables such as the price-dividend ratio.