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Licensed Unlicensed Requires Authentication Published by De Gruyter December 16, 2008

The Consumption-Wealth Ratio under Asymmetric Adjustment

Vasco J. Gabriel, Fernando Alexandre and Pedro Bação

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 dynamic 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.

Published Online: 2008-12-16

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