Consumption, change in expectations and equity returns

Using quarterly data for the period 1959 to 2008, I study the relationship between excess stock returns and the change in expectations of the consumption--wealth ratio and of future long-run consumption growth. Using a vector error correction model (VECM), I estimate revisions in expectations on the consumption--wealth ratio and on the discounted value of future consumption growth; the latter being of high relevance in the asset pricing literature but difficult to identify empirically. My findings show that these variables are strong predictors of future excess stock returns when compared to several common predictor variables. Furthermore, these results seem to be robust in out-of-sample and in-sample analyses, and appear not to be driven by persistence.