Interpretable Asset Markets?

In this paper we show that measures of economic uncertainty (conditional volatilityof consumption) predict and are predicted by valuation ratios at long horizons. Furtherwe document that asset valuations drop as economic uncertainty rises — that is,financial markets dislike economic uncertainty. Moreover, future earnings growth ratesare sharply predicted by current price-earnings ratios. It seems that much of thevariation in asset prices can be attributed to fluctuations in economic uncertainty andexpected cash-flow growth. This empirical evidence is consistent with the implicationsof existing parametric general equilibrium models. Hence, the channels of fluctuatingeconomic uncertainty and expected growth seem important for interpreting assetmarkets.