Wealth‐to‐Income Ratio and Stock Market Movements: Evidence from a Nonparametric Causality Test

• Published date: 01 September 2018
• DOI: http://doi.org/10.1111/irfi.12136
• Author: Mark E. Wohar,Mehmet Balcilar,Ricardo M. Sousa,Rangan Gupta
• Date: 01 September 2018

Wealth-to-Income Ratio and Stock

Market Movements: Evidence from a

Nonparametric Causality Test

MEHMET BALCILAR

†,‡,§

,RANGAN GUPTA

§

,RICARDO M. SOUSA

¶,††

AND

MARK E. WOHAR

‡‡,§§

†

Eastern Mediterranian University, Famagusta, North Cyprus, Turkey,

‡

Montpellier Business School, Montpellier, France,

§

University of Pretoria, Pretoria, South Africa,

¶

University of Minho, Braga, Portugal,

††

LSE Alumni Association, London, UK,

‡‡

University of Nebraska-Omaha, Omaha, NE, USA and

§§

Loughborough University, Loughborough, UK

ABSTRACT

We use a nonparametric causality-in-quantile test to analyze the predictive

ability of the wealth-to-income ratio (wy) for excess stock returns and their

volatility.Our results reveal that the wy is nonlinearly related with excess stock

returns, and hence, results from linear Granger causality tests cannot be

deemed robust. When we apply the nonparametric causality-in-quantile test,

we find that the wy can predict excess stock returns over the majority of the

conditional distribution, with the exception being the extreme ends, that is,

when the market is in deep bear or bull phases. However, the wy has no

predictability for the volatility of excess stock returns.

JEL Codes: C22; G10

I. INTRODUCTION

The seminal paper by Lettau and Ludvigson (2001) was the predecessor of a

sequence of works investigating the link between the consumption-wealth

ratio (denoted by cay) and risk premium, including stock and bond returns

in both developed and developing markets (Afonso and Sousa 2011; Rocha

Armada and Sousa 2012; Rapach and Zhou 2013; Sousa 2010a, 2015; Caporale

et al. 2016).

A recent work of Sousa (2015) has made a substantial contribution to the

empirical finance literature. The author develops a very simple theoretical model

that shows that falls in asset wealth are equivalent to a destruction of collateral or

a reduction in utility services. As a result, when hit by negative shocks, investors

become more exposed to labor income risk and demand a larger risk premium on

© 2017 International Review of Finance Ltd. 2017

International Review of Finance, 2017

DOI: 10.1111/irfi.12136

International Review of Finance, 18:3, 2018: pp. 495–506

DOI:10.1111/irfi.12136

© 2017 International Review of Finance Ltd. 2017