Transitory Deviations Research Articles

Stock return predictability and cyclical movements in valuation ratios

According to present-value models, financial valuation ratios should predict future stock returns or cash flows; however, when tested empirically, these ratios show little power. This paper develops insights into stock return predictability and reconciles the contradictory findings about the information provided by financial ratios. We decompose a financial ratio into a slow-moving component that reflects the time-varying local mean, and a cyclical component that reflects the transitory deviations of the ratio from its local mean. The cyclical components deliver substantially improved in- and out-of-sample forecast gains of stock returns and cash flows relative to the original financial ratios and the historical average benchmark. Conversely, the slow-moving components fail to predict returns, and therefore they are found to disguise the predictive information contained in the financial ratios for stock returns and cash flows.

Corporate Leverage and the Dynamics of Its Components

AbstractWe investigate the dynamics of observed and target leverage ratios and deviations from the targets. The cross-sectional persistence in leverage ratios is driven by persistent targets, whereas time-series variation is driven by transitory deviations from targets. Consistent with dynamic trade-off theories, persistence is higher when the costs of deviating from targets are lower and when the adjustment costs are higher. Deviations are less persistent for firms that are over-levered and firms that are smaller, younger, or more focused or that have lower credit ratings. In recessions, excess leverage is less persistent for larger firms and is more persistent for smaller firms.

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

AbstractWe 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.

Corporate Leverage and the Dynamics of Its Components

We investigate the dynamics of observed and target leverage ratios and deviations from the targets. The cross-sectional persistence in observed leverage ratios is driven by highly persistent targets, whereas the time series variation is driven by transitory deviations from targets. Deviations are less persistent for firms that are overlevered and firms that are smaller, younger, focused, or have lower credit ratings. In recessions, excess leverage is less persistent for larger firms and is more persistent for smaller firms. Thus, consistent with dynamic trade-off theories, persistence is higher when the costs of deviating from targets are likely to be lower and when the costs of adjustment are likely to be higher.

Is the Cycle the Trend? Evidence From the Views of International Forecasters

We revisit the conventional view that output fluctuates around a stable trend by analyzing professional long-term forecasts for 38 advanced and emerging market economies. If transitory deviations around a trend dominate output fluctuations, then forecasters should not change their long-term output level forecasts following an unexpected change in current period output. By contrast, an analysis of Consensus Economics forecasts since 1989 suggest that output forecasts are super-persistent—an unexpected 1 percent upward revision in current period output typically translates into a revision of ten year-ahead forecasted output by about 2 percent in both advanced and emerging markets. Drawing upon evidence from the behavior of forecast errors, the persistence of actual output is typically weaker than forecasters expect, but still consistent with output shocks normally having large and permanent level effects.

Is the Cycle the Trend? Evidence from the Views of International Forecasters

We revisit the conventional view that output fluctuates around a stable trend by analyzing professional long-term forecasts for 38 advanced and emerging market economies. If transitory deviations around a trend dominate output fluctuations, then forecasters should not change their long-term output level forecasts following an unexpected change in current period output. By contrast, an analysis of Consensus Economics forecasts since 1989 suggest that output forecasts are super-persistent—an unexpected 1 percent upward revision in current period output typically translates into a revision of ten year-ahead forecasted output by about 2 percent in both advanced and emerging markets. Drawing upon evidence from the behavior of forecast errors, the persistence of actual output is typically weaker than forecasters expect, but still consistent with output shocks normally having large and permanent level effects.

Leverage Persistence and Corporate Dynamic Tradeoff Behavior

We investigate the dynamics of observed and target leverage ratios and deviations from the targets. The cross-sectional persistence in observed leverage ratios is driven by highly persistent targets, whereas the time series variation is driven by transitory deviations from targets. Deviations are less persistent for firms that are overlevered and firms that are smaller, younger, focused, or have lower credit ratings. In recessions, excess leverage is less persistent for larger firms and is more persistent for smaller firms. Thus, consistent with dynamic trade-off theories, persistence is higher when the costs of deviating from targets are likely to be lower and when the costs of adjustment are likely to be higher.

Earnings Dynamics and Measurement Error in Matched Survey and Administrative Data

This paper analyses the measurement error and earnings dynamics of two sources of individuals' annual earnings from Statistics New Zealand's Survey of Family, Income and Employment (SoFIE) and administrative linked employer-employee data (LEED) earnings reported in the Integrated Database Infrastructure (IDI). First, SoFIE reported earnings are 2-4% lower than LEED earnings on average, and slightly more variable; while the difference between the two reported earnings accounts for 25-30% of the variance in either report. Second, we reject the joint hypothesis that SoFIE earnings are reported with classical measurement error and LEED earnings are recorded without error. We estimate that the statistical reliability of LEED measured earnings (0.87{0.91) is higher than that of SoFIE earnings (0.83{0.85). Third, the differences between SoFIE and LEED earnings are negatively correlated with both individuals' average (LEED) earnings over the sample period and their annual transitory deviations. These differences can be characterised longitudinally by both persistent and serially correlated transitory factors. Fourth, we formulate and estimate a model for SoFIE and LEED earnings, which includes dynamics for true earnings and for measurement errors in both SoFIE and LEED. Female earnings are more variable than males', due both to permanent and transitory effects, and transitory shocks are relatively stronger for women. Allowing for measurement error in LEED, we find no evidence of mean-reverting error in SoFIE. Fifth, the models imply measurement errors dominate the observed changes in male earnings, and account for large fractions of the changes in female earnings.

Can the Consumption–Wealth Ratio Predict Housing Returns? Evidence from OECD Countries

AbstractWe use a representative consumer model to analyze the relation between the transitory deviations of consumption from its common trend with aggregate wealth and labor income, cay, and the housing risk premium. The evidence based on data for 15 OECD countries shows that, if financial and housing assets are seen as complements, investors will temporarily allow consumption to rise when they expect a rise in future housing returns. By contrast, if housing assets are treated as substitutes for financial assets, consumption will be reduced.

Consumption, wealth, stock and housing returns: Evidence from emerging markets

We test the predictive ability of the transitory deviations of consumption from its common trend with aggregate wealth and labour income, cay, for both future equity and housing risk premia in emerging market economies. Using quarterly data for 31 markets, our country-level evidence shows that forecasting power of cay vis-à-vis stock returns is high for Brazil, China, Colombia, Israel, Korea, Latvia and Malaysia. As for housing returns, the empirical evidence suggests that financial and housing assets are perceived as complements in the case of Chile, Russia, South Africa and Thailand, and as substitutes in Argentina, Brazil, Hong Kong, Indonesia, Korea, Malaysia, Mexico and Taiwan. Using a panel econometric framework, we find that the cross-country heterogeneity observed in asset return predictability does not accrue to regional location, but can be attributed to differences in the degree of equity market development and in the level of income.

Konjunkturbereinigungsverfahren der Länder: Eine Quasi-Echtzeitanalyse am Beispiel Schleswig-Holsteins

Im Zuge der Schuldenbremse sind die Lander gehalten, ihre Haushalte ohne Nettoneuverschuldung auszugleichen. Ein konjunktureller Ausgleich ist jedoch erlaubt, sodass die Frage der Konjunkturbereinigung fur die Landerhaushalte relevant wird. Da angenommen wird, dass in den Landerhaushalten nur die Steuereinnahmen konjunktursensibel sind, konnen neben dem indirekten Verfahren, das von der gesamtwirtschaftlichen Produktionslucke uber Budgetsensitivitaten auf die Konjunkturkomponente schliest und das beim Stabilitatsrat und im Bund angewandt wird, auch Trendsteuerverfahren die Konjunkturbereinigung gewahrleisten. Die Arbeit vergleicht verschiedene Verfahren in Quasi-Echtzeit mit Blick auf ihre Symmetrieeigenschaften und Revisionsanfalligkeit. Zudem wird berucksichtigt, wie sich das jeweilige Konjunkturbereinigungsverfahren zur mittelfristigen Finanzplanung verhalt. Als Trendsteuerverfahren werden der Hodrick-Prescott-Filter und log-lineare Trends fur unterschiedliche Stutzzeitraume sowie das Verfahren, das derzeit in Rheinland-Pfalz genutzt wird, berucksichtigt. Ferner wird der Einfluss von Steuerrechtsanderungen und die Bedeutung von Prognosen fur die Trendsteuerverfahren behandelt. Schlieslich wird ein Echtzeittrendglatter vorgeschlagen, der die Revisionsanfalligkeit von Trendsteuerverfahren reduziert und dabei die Symmetrieeigenschaften beibehalten soll.

A nonparametric analysis of firm size, leverage and labour productivity distribution dynamics

This paper investigates the evolution of firm distributions for entrant manufacturing firms in Canada using nonparametric methods. These nonparametric methods use functional principal components to describe these densities over time. This method is applied to a novel administrative firm-level database from Statistics Canada to investigate the evolution of the 1985 and 1989 cohorts of new entrants. We find that firm leverage (debt-to-asset ratio) distributions have persistent deviations from the initial distributions. Bootstrap test statistics suggest that the distributions are different across all time periods. Firm size and labour productivity have transitory deviations and some of the distributions are the same across all time periods. Univariate finite mixture and stochastic dominance tests are used to conduct pairwise comparisons as robustness measures. We find that these static pairwise comparisons confirm the dynamic evolution of these densities. This method illustrates the efficacy of functional principal components to analyse firm distributions.

The Asymmetric Business Cycle

Abstract The business cycle is a fundamental yet elusive concept in macroeconomics. In this paper, we consider the problem of measuring the business cycle. First, we argue for the output-gap view that the business cycle corresponds to transitory deviations in economic activity away from a permanent, or trend, level. Then we investigate the extent to which a general model-based approach to estimating trend and cycle for the U.S. economy leads to measures of the business cycle that reflect models versus the data. We find empirical support for a nonlinear time series model that produces a business cycle measure with an asymmetric shape across NBER expansion and recession phases. Specifically, this business cycle measure suggests that recessions are periods of relatively large and negative transitory fluctuations in output. However, several close competitors to the nonlinear model produce business cycle measures of widely differing shapes and magnitudes. Given this model-based uncertainty, we construct a mode...

Are Stock and Housing Returns Complements or Substitutes? Evidence from OECD Countries

In this paper we use a representative consumer model to analyse the equilibrium relation between the transitory deviations from the common trend among consumption, aggregate wealth, and labour income, cay, and focus on the implications for both stock returns and housing returns. The evidence based on data for 15 OECD countries shows that when agents expect future stock returns to be higher, they will temporarily allow consumption to rise. Regarding housing returns, if housing assets are seen as complements to stocks, then investors react in the same way, but if they are instead treated as substitutes consumption will be temporarily reduced.

Are Stock and Housing Returns Complements or Substitutes? Evidence from OECD Countries

In this paper we use a representative consumer model to analyse the equilibrium relation between the transitory deviations from the common trend among consumption, aggregate wealth, and labour income, cay, and focus on the implications for both stock returns and housing returns. The evidence based on data for 15 OECD countries shows that when agents expectfuture stock returns to be higher, they will temporarily allow consumption to rise. Regarding housing returns, if housing assets are seen as complements to stocks, then investors react in the same way, but if they are instead treated as substitutes consumption will be temporarily reduced.

Pengaruh Transitory Earnings Pada Penggunaan Rasio E/p Dalam Penilaian Perusahaan: Studi Empirik Di Indonesia

The purposes of this study are, firstly, to confirm the findings of the previous study, whether earnings contain transitory component$. Secondly, to investigate how E/P ratios are affected when firms experience transitory earning changes. Thirdly, tg examine whether the dffirences in E/P ratios across firms-due to differences in the magnitude of transitory earnings will quickly disappear in subsequent years. (Jsingfinancial dan of companies listed in Jakarta Stock Exchange (JSE).from the periods of 1993 to 2003, the study finds that earning changes etehibit a transitory component. Under the condition of transitory earnings, .fir*'t E/P ratio is positively affected by the changes in earnings. Industry-adjusted earning changes variable is shown to have a high explanqtory power in predicting-firm's E/P ratio. As the variation offirm's E/P ratios are mainly explained by the transitory component of earnings, time series pattern of E/P ratios reflects transitory deviations due to the transitorycomponent of earnings changes.

To consume or not: How oil prices affect the comovement of consumption and aggregate wealth

This paper provides insight into how oil price movements affect the consumption choices of U.S. households through the wealth channel. Lettau and Ludvigson (2001) show that while consumption, asset wealth, and labor income share a common long-term trend; they substantially deviate from one another in the short run. In this paper, I show that these transitory deviations can be explained by fluctuations in the price of crude oil. Linear and threshold multivariate autoregressive models are used to measure the oil price effect. Oil price effect on the consumption to aggregate wealth ratio is robust to monetary policy effect, sub-period effect, and econometric specifications of oil price effect. Generally speaking, higher (lower) oil price will lead to a decrease (increase) in the proportion of aggregate wealth consumed. In addition, the magnitude of the oil price effect is asymmetric and sub-period dependent. Oil price effect was higher before the 1980's than in succeeding periods.

Extending a SVAR Model of the Australian Economy*

Dungey and Pagan (2000) present a SVAR model of the Australian economy which models macroeconomic outcomes as transitory deviations from a deterministic trend. In this paper we extend that model in two directions. First, we relate it to an emerging literature on Dynamic Stochastic General Equilibrium modelling of small open economies. Second, we allow for both transitory and permanent components in the series and show how this modification has an impact on the design of macroeconomic models.

Stock prices–inflation puzzle and the predictability of stock market returns

This paper considers a new perspective on the relationship between stock prices and inflation, by estimating the common long-term trend in the earning–price ratio and inflation. We find that the transitory deviations from this common trend exhibit substantial out-of-sample forecasting abilities for excess returns at short and intermediate horizons.

Stock Prices, Inflation and Stock Returns Predictability

This paper considers a new perspective on the relationship between stock prices and inflation, by estimating the common long-term trend in real stock prices, as reflected in the earning-price ratio, and both expected and realized inflation. We study the role of the transitory deviations from the common trend in the earning-price ratio and realized inflation for predicting stock market fluctuations. In particular, we find that these deviations exhibit substantial insample and out-of-sample forecasting abilities for both real stock returns and excess returns. Moreover, we find that this variable provides information about future stock returns at short and intermediate horizons that is not captured by other popular forecasting variables.