Labor Income and Predictable Stock Returns |
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Authors: | Santos, Tano Veronesi, Pietro |
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Affiliation: | Columbia University and NBER |
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Abstract: | We propose a novel economic mechanism that generates stock returnpredictability in both the time series and the cross-section.Investors income has two sources, wages and dividendsthat grow stochastically over time. As a consequence the fractionof total income produced by wages fluctuates depending on economicconditions. We show that the risk premium that investors requireto hold stocks varies with these fluctuations. A regressionof stock returns on lagged values of the labor income to consumptionratio produces statistically significant coefficients and largeadjusted R2s. Tests of the models cross-sectional predictionson the set of 25 FamaFrench portfolios sorted on sizeand book-to-market are also met with considerable support. |
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