Real Cash Flow Expectations and Asset Prices

47 Pages Posted: 22 Jun 2021 Last revised: 23 Jun 2021

See all articles by Ricardo De la O

Ricardo De la O

University of Southern California - Marshall School of Business

Sean Myers

The Wharton School, University of Pennsylvania

Date Written: June 22, 2021

Abstract

Using survey forecasts, we find that systematic errors in expectations of long-term inflation and short-term nominal earnings growth are the main driver of prices and return puzzles for bonds and stocks. We demonstrate this by deriving and testing a single necessary and sufficient condition based on accounting identities. Errors in expectations of short-term inflation and long-term nominal earnings growth do not play a role in either asset market. Because of these systematic errors, real cash flow expectations closely match aggregate bond and stock prices, leaving little room for time-varying discount rates. These expectations also accurately match key return puzzles for bonds and stocks: the rejection of the expectations hypothesis and stock return predictability. These results are consistent with a simple model in which agents believe the persistences of inflation and nominal earnings growth are magnified versions of the objective persistences.

Keywords: subjective expectations, inflation expectations, return predictability, expectations hypothesis

JEL Classification: E31, G02, G10, G12, G14

Suggested Citation

De la O, Ricardo and Myers, Sean, Real Cash Flow Expectations and Asset Prices (June 22, 2021). USC Marshall School of Business Research Paper Sponsored by iORB, No. Forthcoming, Available at SSRN: https://ssrn.com/abstract=3867773 or http://dx.doi.org/10.2139/ssrn.3867773

Ricardo De la O (Contact Author)

University of Southern California - Marshall School of Business ( email )

701 Exposition Blvd, HOH 431
Los Angeles, CA California 90089-1424
United States

Sean Myers

The Wharton School, University of Pennsylvania ( email )

The Wharton School
3620 Locust Walk
Philadelphia, PA 19104
United States

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