This paper studies the role of fluctuation of the aggregate consumption-wealth ratio(cay) for predicting Taiwan stock return. The effect of cay on U.S. stock return has been recently confirmed by Lettau and Ludvigson (2001) with a two stage method. In the first step, estimate the ratio used a dynamic least square(DLS) technique. Second, to investigate the performance of cay, they use in-sample and out-of-sample test. In this paper, we follow the method which Lettau and Ludvigson(2001) use to examine the predictability of cay. Using quarterly market data from 1998 to 2010, we find cay is strong predictors of excess return in out-of sample test. We also find that this ratio is a better forecaster of future returns at intermediate horizons compared to short time.

Submitted by Andressa Souza Campos Monteiro de Castro (dessascmc@gmail.com) on 2015-04-29T19:10:59Z No. of bitstreams: 1 Dissertacao_final.pdf: 676467 bytes, checksum: fdc9136b5dfb8c962d18e88e3f041564 (MD5) / Approved for entry into archive by BRUNA BARROS (bruna.barros@fgv.br) on 2015-04-30T14:49:43Z (GMT) No. of bitstreams: 1 Dissertacao_final.pdf: 676467 bytes, checksum: fdc9136b5dfb8c962d18e88e3f041564 (MD5) / Approved for entry into archive by Marcia Bacha (marcia.bacha@fgv.br) on 2015-05-04T12:47:02Z (GMT) No. of bitstreams: 1 Dissertacao_final.pdf: 676467 bytes, checksum: fdc9136b5dfb8c962d18e88e3f041564 (MD5) / Made available in DSpace on 2015-05-04T12:47:13Z (GMT). No. of bitstreams: 1 Dissertacao_final.pdf: 676467 bytes, checksum: fdc9136b5dfb8c962d18e88e3f041564 (MD5) Previous issue date: 2015-03-20 / This paper investigates the role of consumption-wealth ratio on predicting future stock returns through a panel approach. We follow the theoretical framework proposed by Lettau and Ludvigson (2001), in which a model derived from a nonlinear consumer’s budget constraint is used to settle the link between consumption-wealth ratio and stock returns. Using G7’s quarterly aggregate and financial data ranging from the first quarter of 1981 to the first quarter of 2014, we set an unbalanced panel that we use for both estimating the parameters of the cointegrating residual from the shared trend among consumption, asset wealth and labor income, cay, and performing in and out-of-sample forecasting regressions. Due to the panel structure, we propose different methodologies of estimating cay and making forecasts from the one applied by Lettau and Ludvigson (2001). The results indicate that cay is in fact a strong and robust predictor of future stock return at intermediate and long horizons, but presents a poor performance on predicting one or two-quarter-ahead stock returns.