Working Paper: NBER ID: w23689
Authors: Anisha Ghosh; George M. Constantinides
Abstract: The market price-dividend ratio is highly correlated with several macroeconomic variables, particularly inflation and labor market variables, but not with aggregate consumption and GDP. We incorporate this observation in an exchange economy with learning about the economic regime from consumption history and a latent signal. The estimated model rationalizes the moments of consumption and dividend growth, market return, price-dividend ratio, and real and nominal term structures and the low predictive power of the price-dividend ratio for consumption and dividend growth while a nested model with learning from consumption history alone does not. The intuition is that the beliefs process has high persistence and low variance because beliefs depend on the signal. The model fit remains largely intact when we replace the latent signal with a combination of macroeconomic variables that heavily loads on inflation and labor market variables. The results highlight the informational role of macroeconomic variables and suggest that just one combination of macroeconomic variables, along with consumption, proxies well for investors’ relevant information set.
Keywords: Asset Prices; Macroeconomic Variables; Investor Behavior; Price-Dividend Ratio
JEL Codes: D00; E00; G12; G14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| expanding the information set available to investors to include macroeconomic variables (E19) | enhances the explanatory power of asset pricing models (G12) |
| broader information set (D89) | more accurate representation of the price-dividend ratio (G35) |
| persistence and low variance of the beliefs process (D80) | current beliefs are highly informative about future economic conditions (D83) |
| the pricedividend ratio (G35) | highly responsive to changes in beliefs (D91) |
| expanded information set (D80) | improved model performance (C52) |