Finance and Economics Discussion Series - Mary Ward Otto - Bog

This paper examines the relationship between movements in consumer sentiment and stock prices. At the aggregate level, the two share a strong contemporaneous relationship: an increase in equity values boosts sentiment. However, I examined the nature of the relationship between the two. Does an increase in stock prices raise aggregate sentiment because people are wealthier or because they use movements in stock prices as an indicator of future economic activity and potential labor income growth? Using individual observations from the Michigan survey I found results more consistent with the view that people use movements in equity prices as a leading indicator. Although the findings do not rule out a traditional wealth effect, they do raise some questions about the causal role of wealth in aggregate spending.