On the predictive power of the surplus consumption ratio

This paper shows that the surplus consumption ratio, specified by Campbell and Cochrane [1999. Journal of Political Economy 107, 205-251], is a good predictor of excess returns at long horizons. We also provide empirical evidence that this variable captures a component of expected returns, not explained by the proxies for the consumption to wealth ratio, cay and cdy, proposed by Lettau and Ludvigson [2001a. Journal of Finance 56, 815-849; 2001b. Journal of Political Economy 109, 1238-1286; 2005. Journal of Financial Economics 76, 583-626]. Moreover, used as a conditioning information for the Consumption based Asset Pricing Model (C)CAPM, the resulting linear model helps to explain for the variation in average returns across the Fama-French (25) portfolios sorted by size and book-to-market characteristics.