What Information Drives Asset Prices?

Abstract

We contribute to identifying proxies for the information set of investors in financial markets. We show that the marketwide price-dividend ratio highly correlates with inflation and labor market variables that also forecast consumption, dividend, and GDP growth, but not with aggregate consumption or GDP growth. Our model with learning from inflation and wage earnings rationalizes the moments of consumption and dividend growth, market return, the price-dividend ratio, real and nominal term structures, the low predictive power of the price-dividend ratio for consumption and dividends, and the dynamics of the price-dividend ratio, unlike a nested model with learning from consumption alone. (JEL E3, G12, G14) Received March 10, 2020; editorial decision February 25, 2021 by Editor: Nikolai Roussanov. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.