TY - JOUR AU - Campbell,Sean D. AU - Diebold,Francis X. TI - Stock Returns and Expected Business Conditions: Half a Century of Direct Evidence JF - National Bureau of Economic Research Working Paper Series VL - No. 11736 PY - 2005 Y2 - November 2005 UR - http://www.nber.org/papers/w11736 L1 - http://www.nber.org/papers/w11736.pdf N1 - Author contact info: Sean Campbell Division of Research and Statistics Federal Reserve Board 20th Street and Constitution Avenue Washington, DC 20551 Tel: 202.452.3760 Fax: 202.728.5887 E-Mail: sean.d.campbell@frb.gov Francis X. Diebold Department of Economics University of Pennsylvania 3718 Locust Walk Philadelphia, PA 19104-6297 Tel: 215/898-1507 Fax: 212/573-4217 E-Mail: fdiebold@sas.upenn.edu AB - We explore the macro/finance interface in the context of equity markets. In particular, using half a century of Livingston expected business conditions data we characterize directly the impact of expected business conditions on expected excess stock returns. Expected business conditions consistently affect expected excess returns in a statistically and economically significant counter-cyclical fashion: depressed expected business conditions are associated with high expected excess returns. Moreover, inclusion of expected business conditions in otherwisestandard predictive return regressions substantially reduces the explanatory power of the conventional financial predictors, including the dividend yield, default premium, and term premium, while simultaneously increasing R-squared. Expected business conditions retain predictive power even after controlling for an important and recently introduced non-financial predictor, the generalized consumption/wealth ratio, which accords with the view that expected business conditions play a role in asset pricing different from and complementary to that of the consumption/wealth ratio. We argue that time-varying expected business conditions likely capture time-varying risk, while time-varying consumption/wealth may capture time-varying risk aversion. ER -