Do stock market returns predict changes to output? Evidence from a nonlinear panel data model

Abstract

Recent empirical work suggests a predictive relationship between stock returns and output growth. We employ quarterly data from a panel of 27 countries to test whether stock returns as useful in predicting growth. Unlike previous research, our approach allows for the possible non-linear effect of recessions on the growth-return relationship. There is strong evidence to suggest that a linear model would be misspecified and provide potentially misleading inference. Using a switching regression approach, we find evidence that returns are most useful in predicting growth when the economy is in recession.JEL Code: E32

Investment Options and the Business Cycle

“…Moreover, in this case where z is i.i.d., changes in Q will not forecast output. This matches the finding of Henry et al (2005) that the stock market predicts growth better in recessions than in booms.…”

“…By Corollary 1, w is concave in s which means that w s is decreasing in s. By Corollary 2, x is increasing in s so that (z − x) σ is decreasing in s. Thus the claim holds for p and, by (21) it also holds for q.…”

“…Since the firm's problem does not determine X (provided that [21] holds), we shall derive the decision rules for X from the household's problem. The household's Bellman eq.-We shall assume that p = p (s, z) does not depend on k, in which case (21) implies that q (s, z) also does not depend on k. The household's personal state is (k, S), and it takes the aggregate state (k, S, z) and the aggregate laws of motion for (k, S) which depend on the decision rules of other households as given. The household's Bellman equation is…”

Do Indian Economic Activities Impact ASEAN-5 Stock Markets?

“…However, many researchers tend to focus on contagion effect amongst stock markets and ignore the linkages between economic activities and stock market's condition. In fact, both economic activities and stock market's condition play a significant role in determining the direction of portfolio diversification which is especially true during recession (Henry, Ólan, Olekalns & Thong 2004). Moreover, stock markets of countries that are economically integrated tend to respond in similar manners to global economic shocks (Morona, 2008).…”

Comparative Economic Performance and Stock Market Performance: Some Evidence from the Asia-Pacific Region

“…In an empirical work on a sample of 27 countries including G7 2 and Southeast Asian economies, Henry et al (2004) used switching regression analysis to examine the relationship between stock returns and growth rates during the period 1982-2001. The authors concluded that in the Organization for Economic Cooperation and Development (OECD) and in five Southeast Asian countries (Hong Kong, Korea, the Philippines, Singapore, and Taiwan) there was a significant relationship between stock returns and economic growth.…”