Economic Factors and Stock Markets: Empirical Evidence from the UK and the US

Abstract

This paper explores the relationships between security returns and economic factors in an international setting, namely, the UK and the US. Canonical correlation analysis is used to investigate a set of economic indicators as systematic influences on security returns. The results show that the canonical correlation analysis successfully links the stock market factors and the economic forces. Such a method appears to represent an innovation for empirical research on the Arbitrage Pricing Theory (APT). As a result, the APT factors are identified which are based on the intuition of the APT and, hence, we have a better APT model with which we could successfully relate the factors most closely to identifiable sources of economic risk. On balance, the evidence favours the APT and there is available evidence of inter-market linkage between the UK and the US.