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Procyclicality of the Comovement between Dividend Growth and Consumption Growth

To resolve the "procyclicality puzzle" — stock returns and consumption growth covary procyclically (Duffee (2005)) — this article posits and empirically demonstrates that dividend growth and consumption growth comove procyclically. I analyze a variant of the Campbell and Cochrane model accounting for this procyclical comovement, providing both numerical and an intuitive approximate analytical solution. The procyclical comovement yields a more volatile price-dividend ratio albeit at the cost of a lower equity premium due to the new procyclical component in the amount of risk. Both model-simulated and empirical datasets indicate that the procyclical comovement forecasts excess equity returns.