Consumption, (Dis) Aggregate Wealth and Asset Returns

In this work, we analyse the importance of disaggregation of wealth into main components (financial and housing wealth). We show, from the consumer´s intertemporal budget constraint, that the residuals of the trend relationship among consumption, financial wealth, housing wealth and labor income (summarized by the variable cday) should help to predict U.K quarterly asset returns, and to provide better forecasts than a variable like cay from Lettan and Ludvigson (2001), which considers aggregate wealth instead. Using a sample for the U.K. for the period 1975:Q1 - 2003:Q4, we also find that: (i) financial wealth effects are significantly different from housing wealth efects; (ii) changes in financial wealth are mainly transitory, while changes in housing wealth are better understood as permanent; (iii) the relationship among consumption, (dis)aggregate wealth and labor income was relatively stable over time; (iv) consumption doesn´t react asymmetrically to positive and negative financial (or housing) wealth shocks.