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http://ssrn.com/abstract=272118
 
 

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Labor Income and Predictable Stock Returns


Tano Santos


Columbia Business School; National Bureau of Economic Research (NBER)

Pietro Veronesi


University of Chicago - Booth School of Business; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

May 2001

NBER Working Paper No. w8309

Abstract:     
We propose and test a novel economic mechanism that generates stock return predictability on both the time series and the cross section. In our model, investors' income has two sources, wages and dividends, that grow stochastically over time. As a consequence, the fraction of total income produced by wages changes over time de-pending on economic conditions. We show that as this fraction fluctuates, the risk premium that investors require to hold stocks varies as well. We test the main implications of the model and find substantial support for it. A regression of stock returns on lagged values of the labor income to consumption ratio produces statistically significant coefficients and adjusted R2 's that are larger than those generated when using the dividend price ratio. Tests of the cross sectional implication find considerable improvements on the performance of both the conditional CAPM and CCAPM when compared to their unconditional counterparts.

Number of Pages in PDF File: 59

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Date posted: June 3, 2001  

Suggested Citation

Santos, Tano and Veronesi, Pietro, Labor Income and Predictable Stock Returns (May 2001). NBER Working Paper No. w8309. Available at SSRN: http://ssrn.com/abstract=272118

Contact Information

Tano Santos (Contact Author)
Columbia Business School ( email )
420 West 118th Street
New York, NY 10027
United States
212-854-0489 (Phone)
212-316-9180 (Fax)

National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Pietro Veronesi
University of Chicago - Booth School of Business ( email )
5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
773-702-6348 (Phone)
773-702-0458 (Fax)
Centre for Economic Policy Research (CEPR)
77 Bastwick Street
London, EC1V 3PZ
United Kingdom
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
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