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Confidence, bond risks, and equity returns

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  • Zhao, Guihai

Abstract

I show that investor confidence (size of ambiguity) about future consumption growth is driven by past consumption growth and inflation. The impact of inflation on confidence has moved considerably over time and switched on average from negative to positive in 1997. Motivated by this evidence, I develop and estimate a model in which the confidence process has discrete regime shifts, and I find that the time-varying impact of inflation on confidence enables the model to match bond risks over different subperiods. The model can also account for stock and bond return predictability, and correlation between price-dividend ratios and inflation, among other features of the data.

Suggested Citation

  • Zhao, Guihai, 2017. "Confidence, bond risks, and equity returns," Journal of Financial Economics, Elsevier, vol. 126(3), pages 668-688.
    • Handle: RePEc:eee:jfinec:v:126:y:2017:i:3:p:668-688
    DOI: 10.1016/j.jfineco.2017.09.007
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    Cited by:

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    2. Anmol Bhandari & Jaroslav Borovicka & Paul Ho, 2019. "Survey Data and Subjective Beliefs in Business Cycle Models," Working Paper 19-14, Federal Reserve Bank of Richmond.
    3. Guihai Zhao, 2020. "Ambiguity, Nominal Bond Yields, and Real Bond Yields," American Economic Review: Insights, American Economic Association, vol. 2(2), pages 177-192, June.
    4. Robert A. Connolly & Chris Stivers & Licheng Sun, 2022. "Stock returns and inflation shocks in weaker economic times," Financial Management, Financial Management Association International, vol. 51(3), pages 827-867, September.
    5. Ming Zeng & Guihai Zhao, 2022. "Expectation-Driven Term Structure of Equity and Bond Yields," Staff Working Papers 22-21, Bank of Canada.
    6. Johnson Kakeu, 2023. "Concerns for Long-Run Risks and Natural Resource Policy," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 84(4), pages 1051-1093, April.
    7. Qiang Chen & Yu Han & Ying Huang, 2024. "Market‐wide overconfidence and stock returns," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 44(1), pages 3-26, January.

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    More about this item

    Keywords

    Bond returns; Equity returns; Correlation; Ambiguity; Regime switch;
    All these keywords.

    JEL classification:

    • D03 - Microeconomics - - General - - - Behavioral Microeconomics: Underlying Principles
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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