Stock Return Predictability in a Production Economy

Whether national rural employment guarantee scheme (MGNREGS) introduced during 2006 has increased the farm wage rate substantially to the point that has reduced farm profitability due to the programme. This is still an unsettled issue in the literature. Hence, in this paper, an attempt has been made to analyse these issues utilising cost of cultivation survey data published by the Commission for Agricultural Costs and Prices. With the data of different states from 2000–01 to 2010–11, the study has covered five different foodgrain crops namely paddy, wheat, jowar, bengal gram (channa) and pigeon peas (red gram) for the analysis. The study does not seem to support the argument that the profitability of foodgrain crops has declined after the introduction of MGNREGS. This is not only true with high area with high productivity (HAHP) states but also with high area with low productivity (HALP) states. However, this study shows that the real cost incurred on account of human labour has increased considerably in all five crops in both High and low productivity states during the MGNREGS period (2006–07 to 2010–11) as compared to preceding years. In fact, real profitability even after subtracting the cost of imputed value of family labour cost used in the cultivation of the crops (cost C2) has either increased or the losses incurred reduced in all five crops in both HAHP and HALP states. The number of years profit realised by the farmers has also increased in most crops during post-MGNREGS period as compared to pre-MGNREGS period (2000–01 to 2005–06). Increased productivity of most of these crops also might have helped to increase the profitability of farmers across the country, even taking account increase in human labour cost during the same period.

International Evidence on Analyst Stock Recommendations, Valuations, and Returns

This paper uses a log-linear asset pricing framework and a vector autoregressive model to break down movements in stock and bond returns into changes in expectations of future stock dividends, inflation, short-term real interest rates, and excess returns on stocks and bonds. In monthly postwar U.S. data, excess stock returns are found to be driven largely by news about future excess stock returns, while excess 10-year bond returns are driven largely by news about future inflation. Real interest rate changes have little impact on either stock or 10-year bond returns, although they do affect the short-term nominal interest rate and the slope of the term structure. These findings help to explain why postwar excess stock and bond returns have been almost uncorrelated.

Existing empirical research investigating the size of the equity premium has largely consisted of a series of innovations around a common theme: producing a better estimate of the equity premium by using better data or a better estimation technique. The equity premium estimate that emerges from most of this work matches one moment of the data alone: the mean difference between an estimate of the return to holding equity and a risk-free rate. We instead match multiple moments of U.S. market data, exploiting the joint distribution of the dividend yield, return volatility, and realized excess returns, and find that the equity premium lies within 50 basis points of 3.5%, a range much narrower than was achieved in previous studies. Additionally, statistical tests based on the joint distribution of these moments reveal that only those models of the conditional equity premium that embed time variation, breaks, and/or trends are supported by the data. In order to develop the joint distribution of the dividend yield, return volatility, and excess returns, we need a model of price and return fundamentals. We document that even recently developed analytically tractable models that permit autocorrelated dividend growth rates and discount rates impose restrictions that are rejected by the data. We therefore turn to a wider range of models, requiring numerical solution methods and parameter estimation by the simulated method of moments.

The role of term spread and pattern changes in predicting stock returns and volatility of the United Kingdom: Evidence from a nonparametric causality-in-quantiles test using over 250 years of data

We propose a new modeling framework to study the asset pricing implications of learning under ambiguity aversion. In a continuous time partial information Lucas economy, we characterize analytically equilibrium equity returns and make the following observations. First, learning under ambiguity aversion implies an equilibrium discount for ambiguity, if and only if relative risk aversion is below one or, equivalently, the elasticity of intertemporal substitution (EIS) is above one. In this case, ambiguity aversion increases conditional equity premia and volatilities. Second, equilibrium interest rates are lower, irrespective of risk aversion. Third, no time-invariant relation between excess returns and conditional variances exists. Therefore, estimated relations between excess returns and equity conditional variances are highly time varying and have an indeterminate sign. Fourth, estimates of the EIS based on standard Euler equations for equity returns are strongly downward biased in a setting of learning and ambiguity aversion. Therefore, an EIS well above one can be consistent with estimates of EIS well below one. Fifth, ambiguity does not resolve asymptotically. Finally, using realistic model parameters, we show that a low risk aversion and a moderate amount of ambiguity are consistent with the equity premium, the low interest rate, and the excess volatility puzzles.

How does an economy behave if (1) fundamentals are truly hump-shaped, exhibiting momentum in the short run and partial mean reversion in the long run, and (2) agents do not know that fundamentals are hump-shaped and base their beliefs on parsimonious models that they fit to the available data? A class of parsimonious models leads to qualitatively similar biases and generates empirically observed patterns in asset prices and macroeconomic dynamics. First, parsimonious models will robustly pick up the short-term momentum in fundamentals but will generally fail to fully capture the long-run mean reversion. Beliefs will therefore be characterized by endogenous extrapolation bias and pro-cyclical excess optimism. Second, asset prices will be highly volatile and exhibit partial mean reversion--i.e., overreaction. Excess returns will be negatively predicted by lagged excess returns, P/E ratios, and consumption growth. Third, real economic activity will have amplified cycles. For example, consumption growth will be negatively auto-correlated in the medium run. Fourth, the equity premium will be large. Agents will perceive that equities are very risky when in fact long-run equity returns will co-vary only weakly with long-run consumption growth. If agents had rational expectations, the equity premium would be close to zero. Fifth, sophisticated agents--i.e., those who are assumed to know the true model--will hold far more equity than investors who use parsimonious models. Moreover, sophisticated agents will follow a counter-cyclical asset allocation policy. These predicted effects are qualitatively confirmed in U.S. data.(This abstract was borrowed from another version of this item.)(This abstract was borrowed from another version of this item.)(This abstract was borrowed from another version of this item.)(This abstract was borrowed from another version of this item.)(This abstract was bo(This abstract was borrowed from another version of this item.)

The equity premium - the difference between the return achievable from investment in the equity market (RM ) and the risk-free rate of return (RF )- plays an important part in corporate finance. The expression equity premium (sometimes referred to as the equity risk premium) is used to denote the ex ante expectation of investors. The term excess return refers to the ex post achievement of stock returns over and above the risk-free return. If we compare US and UK returns, we find that total returns, real returns and the value of (RM - RF ) are all marginally higher for the UK. Summarized evidence appears in Table 1 and Table 6. Such greater returns may be due to an increased risk premium related to increasing unexpected inflation. Particularly important in estimating the equity risk premium is whether excess returns are measured using a geometric or an arithmetic mean return. To a significant extent, this question revolves around mean reversion in stock returns. Evidence of mean reversion is substantial, although it cannot be proved unequivocally. Given the weight of evidence of mean reversion, there may be a strong case for the use of a geometric mean with an equity premium of between 3% and 5% - or even less.

Production-Based Asset Pricing in a Monetary Economy: Theory and Evidence

Variable capital utilization is an important element in recent DSGE models. To allow capital utilization to respond to shocks, the cost of varying utilization is modelled in terms of either accelerated depreciation of capital (Greenwood et al., 1988) or foregone consumption (Christiano et al., 2005). We perform a Bayesian estimation of the standard medium-scale DSGE model augmented with news shocks to examine which specification is supported by the data. The former exhibits a superior fit with the data relative to the latter. We show that it is attributable to the fact that the former explains better the properties of nominal variables, such as inflation and nominal interest rates.

Predicting the Equity Premium around the Globe: Comprehensive Evidence from a Large Sample

The Comovement of US and UK Stock Markets

This paper explores asset returns in a production economy with habit forming households. We show that a model with capital adjustment costs and relative habits is consistent with salient financial facts, such as the equity premium, the market price of risk, and the riskfree interest rate. These predictions are not at odds with good business cycle predictions. In the model, economy investment is strongly procyclical and more volatile than output, which in turn is more volatile than consumption. Moreover, consumption growth is positively autocorrelated and negatively (positively) correlated with future (past) stock returns.

This paper studies the impact of recessions on the longer-run level of output using data on 23 advanced economies over the past 40 years. We find that severe recessions have a sustained and sizable negative impact on the level of output. This sustained decline in output raises questions about the underlying properties of output and how we model trend output or potential around recessions. We find little support for the view that output rises faster than trend immediately following recessions to close the output gap. Indeed, we find little evidence that growth is faster following recessions than before; if anything post-trough growth is slower. Instead, we find that output gaps close importantly through downward revisions to potential output rather than through rapid post-recession growth. The revisions are made slowly (over years) – a process that leads to an initial underestimation of the effect of recessions on potential output and a corresponding under-prediction of inflation.

Forecasting the Equity Risk Premium: The Ups and the Downs