The consumption-wealth and book-to-market ratios in a dynamic asset pricing context

Resumen

We discuss whether stock returns in Spain are predictable using a proxy for the logarithm of the consumption-aggregate wealth ratio, specifically the deviations of the common trend in consumption, labor income, and household asset holdings. The predictability regression used is based on intertemporal asset pricing models, which indicate that the consumption-wealth ratio is a function of the expected returns. The difficulties in this unobservable ratio are solved as in Lettau and Ludvigson (2001). The results show a partial capability of the proxy to forecast returns, but a good behavior of the book-to-market ratio as a predictor. A positive and approximate linear relationship between this financial ratio and the macroeconomic variable can be proved theoretically and supported empirically, thus confirming the predictive power of the book-to-market and, of course, its use as a state variable in asset pricing models.