TY - JOUR AU - Campbell,John Y. AU - Giglio,Stefano AU - Polk,Christopher TI - Hard Times JF - National Bureau of Economic Research Working Paper Series VL - No. 16222 PY - 2010 Y2 - July 2010 UR - http://www.nber.org/papers/w16222 L1 - http://www.nber.org/papers/w16222.pdf N1 - Author contact info: John Y. Campbell Morton L. and Carole S. Olshan Professor of Economics Department of Economics Harvard University Littauer Center 213 Cambridge, MA 02138 Tel: 617/496-6448 Fax: 617/495-7730 E-Mail: john_campbell@harvard.edu Stefano Giglio University of Chicago Booth School of Business 5807 S. Woodlawn Avenue Chicago, IL 60637 Tel: 773/834-1957 E-Mail: stefano.giglio@chicagobooth.edu Christopher Polk Department of Finance London School of Economics Houghton St. London WC2A 2AE UK Tel: +44 (0)20 7849 4917 Fax: +44 (0)20 7852 3580 E-Mail: c.polk@lse.ac.uk AB - This paper shows that the stock market downturns of 2000-2002 and 2007-09 have very different proximate causes. The early 2000's saw a large increase in the discount rates applied to corporate profits by rational investors, while the late 2000's saw a decrease in rational expectations of future profits. In each case the downturn reversed the trends of the previous boom. We reach these conclusions using a vector autoregressive model of aggregate stock returns and valuations, estimated imposing the cross-sectional restrictions of the intertemporal capital asset pricing model (ICAPM). As stock returns are very noisy, exploiting an economic model such as the ICAPM to extract information about future corporate profits from realized returns can potentially be very useful. We confirm that the ICAPM restrictions improve the out-of-sample forecasting performance of VAR models for stock returns, and that our conclusions are consistent with a simple graphical data analysis. Our findings imply that the 2007-09 downturn was particularly serious for rational long-term investors, who did not expect a strong recovery of stock prices as they did earlier in the decade. ER -