Prices, Consumption, and Dividends Over the Business Cycle: A Tale of Two Regimes

41 Pages Posted: 17 Nov 2014

See all articles by Anisha Ghosh

Anisha Ghosh

Carnegie Mellon University

George M. Constantinides

University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER)

Date Written: November 2014

Abstract

An economy in which investors know the true model and its parameters and filter the regime probability from aggregate consumption history has been empirically rejected. Hypothesizing that prices partly reflect investors╩╝ belief about the regime, we infer beliefs from prices. The model fits well the moments of the market return, risk free rate, and price-dividend ratio. Consistent with the data, it implies higher mean and lower volatility of consumption and dividend growth rates, lower mean and volatility of the market return and equity premium, and higher mean of the price-dividend ratio in the first regime compared with the second one. The probability of recession in a year is 62:5% (23:7%) if the probability of being in the first regime at the beginning of the year is lower (higher) than 50%. The results support the hypothesis that investors employ a broader information set than just aggregate consumption history in forming their beliefs.

Suggested Citation

Ghosh, Anisha and Constantinides, George M., Prices, Consumption, and Dividends Over the Business Cycle: A Tale of Two Regimes (November 2014). NBER Working Paper No. w20678, Available at SSRN: https://ssrn.com/abstract=2526033

Anisha Ghosh (Contact Author)

Carnegie Mellon University ( email )

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Pittsburgh, PA 15213-3890
United States

George M. Constantinides

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
773-702-7258 (Phone)
773-752-0458 (Fax)

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
United States

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