Financial variables and economic activity in the Nordic countries

Abstract

Kuosmanen, Petri 1 , Nasib Nabulsi 2 & Juuso Vataja (2014). Financial Variables and Economic Activity in the Nordic Countries. University of Vaasa, Department of Economics, Working Papers 23, 29 p. The recent financial crisis has re-highlighted the importance of clarifying the predictive association between financial markets and the real economy. The previous literature suggests that the predictive ability of financial variables for economic growth appears to be largely coincidental for the main industrial countries. This study focuses on similar small open economies in the Nordic context. More specifically, we study the predictive content of stock returns, short-term interest rates and the term spread by using linear models and non-linear regime switching models for forecasting GDP growth in Denmark, Finland, Norway and Sweden. We apply the threshold autoregressive (TAR) model-switching approach and the novel regime-switching signals which combine the inversion of the yield curve and the recession as the signal to switch between economic states. The predictive ability of the observable and known switching approach is compared to the latent switch under the Markov switching approach. The results suggest that the TAR model approach with an inversion-recession signal is preferable for predicting economic activity in all four of the Nordic countries. However, the predictive ability of financial variables may differ between neighboring countries, although the Nordic countries are similar in terms of economic development and financial institutions. Moreover, the link between the financial sector and GDP growth may not depend straightforwardly on monetary regimes. Among the Nordic countries, the predictive relationship between financial variables and economic activity is found to be the strongest in Finland and Sweden.

Stock prices and macroeconomic factors: Some European evidence

“…Recently, Kuosmanen et al (2015) address the predictive association between financial markets and the real economy in four Nordic countries; they find that the relationship between financial variables and economic activity is stronger in Finland and Sweden than in Denmark and Norway. In addition to the scarcity of studies on the relationships between macroeconomic factors and equity prices in European markets, the evolution of these possible relationships over time and the relative importance of the different economic factors have not been addressed at all.…”

European Nordic Countries Stock Market Listed Companies’: Factor and Cluster Analysis Approach

“…Kuosmanen et al (2015) study addresses the predictive association between financial markets and the real economy in the four Nordic countries: Denmark, Finland, Norway and Sweden. Our results suggest that this relationship may differ between neighboring countries even though all of the Nordic countries have a largely equal degree of financial market development, and the countries were similarly affected by the recent severe recession of financial-market origin [22]. Butt and Virk (2015) presents a simplified single period asset-pricing model adjusted for liquidity and tests it for the Nordic markets.…”

Economic policy uncertainty effects for forecasting future real economic activity

“…Hence, in our paper, the main novel idea is to analyze thoroughly the role of economic policy uncertainty in the models that utilize financial market information for forecasting the future values of real macroeconomic activity. The fundamental form of our forecasting model is based on the previous studies by, e.g., Stock and Watson (2003), Haubrich (2008a and2008b), Junttila and Korhonen (2011), and Kuosmanen, Nabulsi and Vataja (2015). The common theme in all these studies has been to use only asset market return variables for forecasting the future values of various kinds of macroeconomic variables, like, for example, GDP and/or industrial production growth, inflation and real exchange rates.…”

“…However, when comparing the results from the two sub-periods in the euro area data, our findings regarding the role of stock market performance in forecasting the future real economic activity seem to be clearly different. A priori, based on earlier empirical findings (see for example Stock and Watson, 2003;Kuosmanen et al, 2015;Junttila and Korhonen, 2011) and on the theoretical ideas in the Gordon (1962) dividend pricing model and the Cochrane (2006) discount factor analysis, future real economic activity should be positively related to the current valuation of common stocks.…”