Consumption-Wealth Ratio and Expected Stock Returns: Evidence from Panel Data on G7 Countries^*

Using the theoretical framework of Lettau & Ludvigson (2001), we perform an empirical investigation on how widespread is the predictability of cay-a modified consumption-wealth ratio-once we consider a set of important countries from a global perspective. We chose to work with the set of G7 countries, which represent more than 64% of net global wealth and 46% of global GDP at market exchange rates. We evaluate the forecasting performance of cay using a paneldata approach, since applying cointegration and other time-series techniques is now standard practice in the panel-data literature. Hence, we generalize Lettau and Ludvigson's tests for a panel of important countries. We employ macroeconomic and financial quarterly data for the group of G7 countries, forming an unbalanced panel. For most countries, data is available from the early 1990s until 2014Q1, but for the U.S. economy it is available from 1981Q1 through 2014Q1. Results of an exhaustive empirical investigation are overwhelmingly in favor of the predictive power of cay in forecasting future stock returns and excess returns.

Keywords:
Consumption-Wealth Ratio; Stock Returns; Unbalanced Panel; Cointegrating Residual