American Economic Review: Vol. 97 No. 5 (December 2007)

DellaVigna, Stefano, and Joshua M. Pollet. 2007. "Demographics and Industry Returns." American Economic Review, 97(5): 1667-1702.

DOI: 10.1257/aer.97.5.1667

How do investors respond to predictable shifts in profitability? We consider how demographic shifts affect profits and returns across industries. Cohort size fluctuations produce forecastable demand changes for age-sensitive sectors, such as toys, bicycles, beer, life insurance, and nursing homes. These demand changes are predictable once a specific cohort is born. We use lagged consumption and demographic data to forecast future consumption demand growth induced by changes in age structure. We find that demand forecasts predict profitability by industry. Moreover, forecast demand changes five to ten years in the future predict annual industry stock returns. One additional percentage point of annualized demand growth due to demographics predicts a 5 to 10 percentage point increase in annual abnormal industry stock returns. However, forecasted demand changes over shorter horizons do not predict stock returns. A trading strategy exploiting demographic information earns an annualized risk-adjusted return of approximately 6 percent. We present a model of inattention to information about the distant future that is consistent with the findings. We also discuss alternative explanations, including omitted risk-based factors. (JEL E21, G12, G32, J11, L11, L25)

DellaVigna, Stefano (University of California, Berkeley and NBER)
Pollet, Joshua M. (University of Illinois)

E21: Macroeconomics: Consumption; Saving; Wealth
G12: Asset Pricing; Trading volume; Bond Interest Rates
G32: Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure
J11: Demographic Trends and Forecasts; General Migration
L11: Production, Pricing, and Market Structure; Size Distribution of Firms
L25: Firm Performance: Size, Diversification, and Scope