Demographic change, consumption and equity returns. An international approach

Abstract

This paper studies the power of demographic change effects on aggregate consumption to explain the life-cycle portfolio behavior of investors. Evidence suggests that the consumption growth of the marginal agent, which accounts for time-varying population and cohort sizes, exhibits more persistence and predictability than aggregate consumption growth. On this basis, we use the cross-sectional regression of consumption growth for 23 developed countries on both their birth and death rates to, subsequently, evaluate the explanatory power of the slopes resulting from this regression in each time period on the cross-section of international equity returns. Our results show that these slope coefficients -and hence the variation in consumption growth induced by demographic changes- contribute significantly to improving the performance of the classic consumption-based asset pricing model in a set of well-differentiated portfolios. Furthermore, we find that stocks that have positive betas on birth rates and negative betas on death rates should provide relatively high expected returns, suggesting the existence of a positive relationship between population ageing and asset prices. This pattern has strong implications for social security, immigration policy, and health programs, among other issues.