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
This paper attempts to provide a comprehensive depiction of the dynamics of the correlation structure of international equity returns. In this pursuit, we employ a powerful yet parsimonious dynamic latent factor model with time-varying loadings and stochastic volatility. Such a specification allows us to account for the complex dynamics between international equity returns but is flexible enough to be estimated with a sample of daily data spanning over 20 years across a geographically diverse set of 15 major international markets. We first document that average global and regional correlations have risen steadily over the past two decades. Our main findings are that international equity returns have become increasingly exposed to common sources of variation, and that the entire low-frequency change in equity correlations is due to changing risk exposures rather than changing systematic risk. We also demonstrate significant financial contagion effects during the 1994 Mexican and 1997 Asian crises.
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