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Business Cycles, Regime Shifts, and Return Predictability

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  • Yang, Wei

Abstract

Consistent with the empirical properties of the consumption data, I develop a model in which consumption and dividend growth follow regime-switching dynamics. I show that regime-shift risk is priced in the model. Regime-shift risk exhibits dominant influence on asset prices: It generates a high equity premium and also induces time-varying risk premiums. The model explains major business cycle-dependent asset market phenomena and, in particular, the stronger predictability of stock returns during recessions.

Suggested Citation

  • Yang, Wei, 2023. "Business Cycles, Regime Shifts, and Return Predictability," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 58(7), pages 3058-3084, November.
    • Handle: RePEc:cup:jfinqa:v:58:y:2023:i:7:p:3058-3084_10
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