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Professor Stijn Van Nieuwerburgh's paper on "Rational Attention Allocation over the Business Cycle" assesses whether mutual fund managers have skill typically regards market timing or stock picking skills as immutable attributes of a manager or fund.

Yet, measures of these skills appear to vary over the business cycle. This paper offers a rational explanation, arguing that timing and picking are tasks. A skilled manager can choose how much of each task to attend to. Using tools from the rational inattention literature, we show that in booms, a manger should pick stocks and in recessions, he should pay more attention to his market timing. The model predicts equilibrium outcomes in a world where a fraction of managers have skill and invest alongside unskilled investors. The predictions about funds' covariance with payoff shocks, cross-fund dispersion, and their excess returns are all supported by the data. In turn, these findings offer new evidence to support two broader ideas: that some investment managers have skill and that attention is allocated rationally.


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We review the literature on return and cash flow growth predictability form the perspective of the present-value identity. We focus predominantly on recent work. Our emphasis is on U.S. aggregate stock return predictability, but we also discuss evidence from other asset classes and countries.
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This paper focuses on two popular predictive variables that are often used to forecast stock market returns: the dividend yield and the price earnings ratio. First, we question the theoretical premise that the dividend yield ought to have predictive power for the aggregate stock market. By referring to the Modigliani and Miller (1961) theorem that dividend policy is irrelevant, but allowing for uncertainty, we show that the dividend yield might not be the appropriate variable to forecast returns on equity. In addition, we show that the dividend yield for stock indexes tends toward the dividend yield of the fastest growing firm in the index, thereby introducing a downward trend in the dividend yield. On the other hand, the earnings yield provides a good proxy for the expected return under mild conditions: if the return on aggregate investment coincides with the expected market return and expected returns form a martingale sequence. Our theoretical findings are confirmed in the S&P 500 data: prices seemingly overreact to dividends, even in the long-run, as suggested by the long-run elasticity of prices with respect to dividends of about 1.5 as first observed by Barsky and DeLong (1993). The long-run elasticity of prices with respect to earnings, however, is insignificantly different from one, suggesting that the focus on dividends alone might be rather misguiding in judging the efficiency of the market. Accounting for these facts, simple tests of market efficiency can be constructed. We find that, in the short-run, the efficient markets hypothesis cannot be rejected.
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Value stocks have higher exposure to innovations in the nominal bond risk premium than growth stocks. Since the nominal bond risk premium measures cyclical variation in the market's assessment of future output growth, this results in a value risk premium provided that good news about future output lowers the marginal utility of wealth today. In support of this mechanism, we provide new historical evidence that low return realizations on value minus growth, typically at the start of recessions when nominal bond risk premia are low and declining, are associated with lower future dividend growth rates on value minus growth and with lower future output growth. Motivated by this connection between the time series of nominal bond returns and the cross-section of equity returns, we propose a parsimonious three-factor model that jointly prices the cross-section of returns on portfolios of stocks sorted on book-to-market dimension, the cross-section of government bonds sorted by maturity, and time series variation in expected bond returns. Finally, a structural dynamic asset pricing model with the business cycle as a central state variable is quantitatively consistent with the observed value, equity, and nominal bond risk premia.
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We derive new estimates of total wealth, the returns on total wealth, and the wealth effect on consumption. We estimate the prices of aggregate risk from bond yields and stock returns using a no-arbitrage model. Using these risk prices, we compute total wealth as the price of a claim to aggregate consumption. We find that US households have a surprising amount of total wealth, most of it human wealth. This wealth is much less risky than stock market wealth. Events in long-term bond markets, not stock markets, drive most total wealth fluctuations. The wealth effect on consumption is small and varies over time with real interest rates.