Abstract:
We use a nonparametric causality-in-quantiles test to compare the predictive ability of the
consumption-wealth ratio (cay) and the Markov Switching version (cayMS) for excess and real
stock and housing returns and their volatility. Our results reveal strong evidence of nonlinearity
and regime changes in the relationship between asset returns and cay or cayMS, which
corroborates the relevance of this econometric framework. Moreover, both cay or cayMS are
found to predict only excess stock returns over its entire conditional distribution, with the latter
being a strong predictor only at certain quantiles. As for the housing market, these two
consumption-wealth ratios only predict the volatility of real housing returns, with cayMS
outperforming cay over the majority of the conditional distribution.
