OVER the weekend, I mentioned some research indicating that rapid population growth can tighten housing markets, helping to reduce the incidence of liquidity traps. As it happens, population trends might also shape the path of equity returns:

Geanakopoulos and his co-authors consider an overlapping generation model in which the demographic structure mimics the pattern of live births in the US, that have featured alternating twenty-year periods of boom and busts. They conjecture that the life-cycle portfolio behaviour – which suggests that agents should borrow when young, invest for retirement when middle-aged, and live off their investment once they are retired – plays an important role in determining equilibrium asset prices. Consumption smoothing by the agents, given the assumed demographic structure, requires that when the middle-aged to young population ratio is small, there will be excess demand for consumption by a large cohort of retirees and for the market to clear, equilibrium prices of financial assets should adjust, i.e. decrease. The result is that saving is encouraged for the middle-aged. As the dividend/price ratio is negatively related to fluctuations in prices, he model predicts a negative relation between this variable and the middle-aged-to-young ratio. In a recent CEPR Discussion Paper (Favero et al. 2010), we take the Geanakopoulos et al. model to the data via the conjecture that fluctuations in the middle-aged-to-young ratio could capture a slowly evolving mean in the dividend price ratio within the dynamic dividend growth model. We find strong evidence in favour of using this variable together with the dividend/price ratio in long-run forecasting regressions for stock market returns...

Somewhat reminiscent of a 2005 paper by Dean Baker, Brad DeLong, and Paul Krugman:

We in America are probably facing a demographic transition—a slowdown in the rate of natural population increase—and possibly facing a slowdown in productivity growth as well. If these two factors do in fact push down the rate of economic growth in the future, is it still prudent to assume that the past performance of assets is an indication of future results? We argue “no.” Simple standard closed-economy growth models predict that growth slowdowns are likely to lower the marginal product of capital, and thus the long-run rate of return. Moreover, if you assume that current asset valuations represent rational expectations, simple arithmetic tells us that it is next to impossible for past rates of return to continue through a forthcoming growth slowdown. Only a large shift in the distribution of income toward capital or current account surpluses larger than those of nineteenth century Britain sustained for generations give promise for reconciling a slowdown in future economic growth with a continuation of historical asset returns.

More attention should probably be paid to the effect of long-wave demographic shifts on markets and economies, as especially on divergent reactions to shocks.