Uncertainty trends, valuation ratios and predictability

65 Pages Posted: 14 Oct 2018 Last revised: 17 Sep 2020

See all articles by Federico M. Bandi

Federico M. Bandi

Johns Hopkins University - Carey Business School

Lorenzo Bretscher

London Business School - Department of Finance

Andrea Tamoni

Rutgers, The State University of New Jersey - Rutgers Business School at Newark & New Brunswick

Date Written: November 17, 2018

Abstract

Even after being orthogonalized with respect to the dividend-price ratio, the volatility of total factor productivity (TFP volatility) is shown to have similar long-run predictive ability for excess market returns as the dividend-price ratio itself. When seen through an asset pricing lens, this finding implies that TFP volatility should also predict real cash flows and/or real interest rates: it is found to mainly predict real cash flows through inflation rates. A model with endogenous growth, Epstein-Zin preferences and nominal price rigidities is shown to reconcile both uncertainty-driven long-run predictability and its real implications. Relying on the model, we justify why alternative notions of uncertainty (like market variance or economic policy uncertainty) have the same predictive ability as TFP volatility provided their priced low-frequency signal is extracted.

Keywords: uncertainty trends, valuation ratios, endogenous growth, price rigidities, financial uncertainty

JEL Classification: C22, E32, E44, G12, G17

Suggested Citation

Bandi, Federico Maria and Bretscher, Lorenzo and Tamoni, Andrea, Uncertainty trends, valuation ratios and predictability (November 17, 2018). Available at SSRN: https://ssrn.com/abstract=3253811 or http://dx.doi.org/10.2139/ssrn.3253811

Federico Maria Bandi

Johns Hopkins University - Carey Business School ( email )

100 International Drive
Baltimore, MD 21202
United States

Lorenzo Bretscher

London Business School - Department of Finance ( email )

Sussex Place
Regent's Park
London NW1 4SA
United Kingdom

Andrea Tamoni (Contact Author)

Rutgers, The State University of New Jersey - Rutgers Business School at Newark & New Brunswick ( email )

1 Washington Park
Newark, NJ 07102
United States

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