Webex-seminar: Does the consumption-income ratio predict returns on wealth? Long-run evidence for industrial economies

Intertemporal budget constraint reasoning suggests that the current aggregate consumption to income ratio may contain information about future returns on wealth. This paper investigates whether this ratio has predictive power for asset returns using historical data over the period 1870 – 2015 for four major industrial economies (France, Germany, the UK and the US). The sign and strength of the predictive relationship are investigated for the excess and raw returns obtained from holding equity and long-term government bonds. The short-run and long-run impact estimates of the log consumption-income ratio on these asset returns are calculated using a Bayesian vector autoregression (VAR) approach with time-varying parameters and stochastic volatilities. We find that the consumption-income ratio has substantial predictive power for, in particular, the (excess) government bond returns of all countries considered. This supports the notion that bond returns may be good proxy's for the returns on total wealth, as is suggested in the literature. The predictive ability of the consumption-income ratio does not appear to be driven by business cycle fluctuations.