Dynamic Factors and the Predictability of Consumption Growth

Posted: 17 Sep 2011

See all articles by Abhay Abhyankar

Abhay Abhyankar

University of Exeter Business School, University of Exeter

Olga Klinkowska

University of Aberdeen - Business School

Date Written: February 1, 2011

Abstract

In this paper we study the predictability of aggregate consumption growth using common factors extracted from a large panel of macroeconomic and financial time series. The stochastic process followed by consumption growth and its predictability by other variables is a key assumption in theoretical models in finance such as consumption-based asset pricing models. Research using empirical data to investigate these aspects of consumption growth is sparse. We find that selected dynamic factors are able to explain up to 36% of the consumption growth variability at quarterly frequency using both in-sample and out-of-sample predictive regressions. We find as well that a single common factor, which summarizes short term interest rates and spreads on bond rates, individually accounts for as much as 23% of this variation. We also conduct a battery of robustness check which further support our main conclusion.

Keywords: E21, E27

JEL Classification: consumption growth, forecasting, dynamic factors

Suggested Citation

Abhyankar, Abhay and Klinkowska, Olga, Dynamic Factors and the Predictability of Consumption Growth (February 1, 2011). Available at SSRN: https://ssrn.com/abstract=1927976

Abhay Abhyankar

University of Exeter Business School, University of Exeter ( email )

Streatham Court
Exeter, EX4 4PU
United Kingdom

Olga Klinkowska (Contact Author)

University of Aberdeen - Business School ( email )

Edward Wright Building
Aberdeen, Aberdeenshire AB24 3QY
United Kingdom

HOME PAGE: http://www.abdn.ac.uk/~bus067/

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