Dynamic relationship between the stock market and macroeconomy in China (1995–2018): new evidence from the continuous wavelet analysis

Rui Wang,Lianfa Li

doi:10.1080/1331677x.2020.1716264

Abstract

This article examines the relationship between the stock market and three widely used macroeconomic variables, namely industrial production growth, inflation, and long-term interest rate in China. We use the continuous wavelet analysis to investigate the correlations and lead–lag relationships between them in the time–frequency domain by covering a period of 1995M01-2018M04. Our findings show the positive relationship between stock returns and industrial production growth and between stock returns and inflation. Notably, we find that stock returns and long-term interest rate are negatively correlated in short and medium terms, while they are positively correlated in the long term. The puzzling positive correlation between stock returns and interest rate as well as the mixed lead–lag relationships suggest that the Chinese stock market is quite undeveloped. There are breakdowns of the link between the stock market and macroeconomy. Neither the stock return can be used as a leading indicator of the macroeconomy nor the real economy could predict the booms or busts of the Chinese stock market.

Highlights

The interactive relationship between the stock market and macroeconomy has attracted attention worldwide for a long time
We find that stock returns and long-term interest rate are negatively correlated in short and medium terms, while they are positively correlated in the long term
Whether the stock market can be viewed as a leading indicator of the real economy, or the stock returns could be predicted using the macroeconomic variables

Summary

Introduction

The interactive relationship between the stock market and macroeconomy has attracted attention worldwide for a long time. Since the macroeconomy is the fundamental of the stock market performance, some studies investigate whether the stock price can be viewed as a leading indicator of the real economy (Borjigin et al, 2018; Croux & Reusens, 2013; Fama, 1990; Gallegati, 2008; Naes, Skjeltorp, & Ødegaard, 2011; Pan & Mishra, 2018; Peiro, 2016; Schwert, 1990; Tiwari et al, 2015). It is of importance to explore the interaction between the stock market and economic factors

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