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Grupo de Estudos Monetários e Financeiros

Estudos do GEMF, N.º 06 de 2007


The Consumption-Wealth Ratio Under Asymmetric Adjustment

(Publicado em Studies in Nonlinear Dynamics & Econometrics 12(4): Article 3, 2008)

Vasco J. Gabriel

Department of Economics, University of Surrey, UK and NIPE-UM

Fernando Alexandre

Department of Economics and NIPE, University of Minho, Portugal

Pedro Bação

GEMF/Faculdade de Economia, Universidade de Coimbra

This paper argues that nonlinear adjustment may provide a better explanation of fluctuations in the consumption-wealth ratio. The nonlinearity is captured by a Markov-switching vector error-correction model that allows the dynamics of the relationship to differ across regimes. Estimation of the system suggests that these states are related to the behaviour of financial markets. In fact, estimation of the system suggests that short-term deviations in the consumption-wealth ratio will forecast either asset returns or consumption growth: the first when changes in wealth are transitory; the second when changes in wealth are permanent. Our approach uncovers a richer and more complex dynamics in the consumption-wealth ratio than previous results in the literature, whilst being in accordance with theoretical predictions of a simple model of consumption under uncertainty.

JEL Classification: C32; C5; E21; E44; G10.

Keywords: Consumption; Financial markets; Uncertainty; Forecast; Markov switching

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