We investigate the influence of changes in UK monetary policy on UK stock returns and the possible reasons behind such a response. Firstly, we conduct an event study to assess the impact of unexpected changes in monetary policy on aggregate and sectoral stock returns. The decomposition of unexpected changes in the policy rate is based on futures markets data. Secondly, using a variance decomposition in the spirit of Campbell (1991) we attempt to identity the channels behind the response of stock returns to monetary policy surprises. The variance decomposition results indicate that the monetary policy shock leads to a persistent negative response in terms of future excess returns for a number of sectors. Copyright 2007 The Authors Journal compilation (c) 2007 Blackwell Publishing Ltd.

We systematically examine the comparative predictive performance of a number of linear and non-linear models for stock and bond returns in the G7 countries. Besides Markov switching, threshold autoregressive (TAR), and smooth transition autoregressive (STAR) regime switching models, we also estimate univariate models in which conditional heteroskedasticity is captured by a GARCH and in which predicted volatilities appear in the conditional mean function. Although we fail to find a consistent winner/out-performer across all countries and markets, it turns out that capturing non-linear effects may be key to improve forecasting. U.S. and U.K. asset return data are "special" in the sense that good predictive performance seems to require that non-linear dynamics be modeled, especially using a Markov switching framework. Although occasionally stock and bond return forecasts for other G7 countries also appear to benefit from non-linear modeling (especially of TAR and STAR type), data from France, Germany, and Italy imply that the best predictive model is often one of the simple benchmarks, such as the random walk and univariate auto-regressions. U.S. and U.K. markets also provide the only data for which we find statistically significant differences between forecasting models. Results appear to be remarkably stable over time, robust to changes in the loss function used in statistical evaluations as well as to the methodology employed to perform pairwise comparisons.

The working papers are produced by The University of Manchester -Manchester Business School and are to be circulated for discussion purposes only. Their contents should be considered to be preliminary. The papers are expected to be published in due course, in a revised form and should not be quoted without the authors' permission. Author(s) and affiliation AbstractThis study investigates the sensitivity of stock returns at the industry level to market, exchange rate and interest rate shocks in the four major European economies: France, Germany, Italy and the UK. In addition to exposure to the market, significant levels of exposure to both exchange rate risk, in the four countries, and interest rate risk, in France and Germany, are identified. Further, responses to sources of risk are decomposed into components attributable to news about future dividends, real interest rates and excess returns. All three sources of risk contain significant information about future cash flows and excess returns. Hyde, S. (2007). The response of industry stock returns to market, exchange rate and interest rate risks. Manchester Business School Working Paper, Number 2007-491, available: http://www.mbs.ac.uk/research/working-papers.aspx. How to quote or cite this documentThe response of industry stock returns to market, exchange rate and interest rate risksStuart Hyde * AbstractThis study investigates the sensitivity of stock returns at the industry level to market, exchange rate and interest rate shocks in the four major European economies: France, Germany, Italy and the UK. In addition to exposure to the market, significant levels of exposure to both exchange rate risk, in the four countries, and interest rate risk, in France and Germany, are identified. Further, responses to sources of risk are decomposed into components attributable to news about future dividends, real interest rates and excess returns. All three sources of risk contain significant information about future cash flows and excess returns.