Investigating the links between growth and real stock price changes with empirical evidence from the G-7 economies

This paper investigates the link between real stock price changes and economic growth. We develop a simple growth model, which presents the relationship between real stock prices and output. Evidence from the G-7 economies by use of the VAR methodology shows that real stock price changes and output growth are strongly related, as predicted by the theoretical model. The bivariate framework also provides useful information for understanding the response of economic growth and real stock prices to external shocks.

Investigating The Links Between Growth And Real Stock Price Changes With Empirical Evidence From The G-7 Economies

This paper shows that the empirical movements of stock prices can be explained directly by fundamentals. The real stock market rate of return is shown to closely track the real incremental rate of profit of the corporate sector, with the two rates displaying similar means and standard deviations. It is argued that the two are linked by capital flows between the sectors through a process we call "turbulent arbitrage". Actual equity prices closely track the prices closely track the prices warranted by this model, and unlike the standard results, are less volatile than the warranted ones. The theoretical approach taken in this paper implies that the incremental profit rate is the required rate of return for the stock market return. The observed volatility on stock market returns and prices arises from the fact that the required rate is itself highly volatile, driven by cyclical and other short term fluctuations in aggregate demand. It is then easy to see why conventional theoretical models, which typically assume constant required rates of return (discount rates) and constant dividend growth rates, are largely unable to explain the movements in stock prices. On the other hand, since the incremental rate of profit (net of interest) is essentially the change in earnings normalized by investment, the findings of this paper accord well the experience "on the street" that stock price movements are driven by interest rates and changes in earnings.

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The Stock Market and the Corporate Sector: A Profit-Based Approach

The paper uses a panel vector autoregression approach to analyze the dynamics of the transition of investment to shocks to fundamental and financial factors in emerging market economies. By relying on a panel of thirty-one emerging economies and quarterly frequency data for the period 1990:1-2008:3, we show that (1) investment sluggishly adjusts to its own shocks; (2) gross domestic product and equity price shocks have a positive and sizable impact on investment; (3) unexpected variation in the cost of capital and the lending rate has a negative effect on investment; and (4) the response of investment to credit market developments seems to be driven by the demand side. In addition, the effects of equity price shocks appear to be similar for emerging Asia and Latin America, but credit shocks are more important in Latin America. Moreover, shocks to the lending rate have a pronounced and negative impact in emerging European markets. Finally, we show that the stock market bubbles may have encouraged real inve...

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Fundamentals, Financial Factors, and the Dynamics of Investment in Emerging Markets

This paper evaluates how well sectoral stock prices forecast future economic activity compared to traditional predictors such as the term spread, dividend yield, exchange rates and money growth. The study is applied to euro area financial asset prices and real economic growth, covering the period 1973 to 2006. The paper finds that the term spread is the best predictor of future growth in the period leading up to the introduction of Monetary Union. After 1999, however, sectoral stock prices in general provide more accurate forecasts than traditional asset price measures across all forecast horizons.

https://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp876.pdf

Are sectoral stock prices useful for predicting euro area GDP

11. The behaviour of equity prices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Investment and share prices.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A. Theoretical considerations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . B. Empirical evidence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . i ) Incremental explanatory power . . . . . . . . . . . . . . . . . . . . . . . . . . . iii) Event analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ii) A decomposition of the explanatory power of stock returns. . . . . .

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Warren Tease

Papers

The stock market and investment