Abstract
Using monthly data from seven mature and emerging markets and a battery of GARCH and EGARCH models, the study of Davis and Kutan (2003) on inflation and output on stock returns and volatility is extended by including interest rate to compare the effect between three mature markets (US, Japan, and Singapore) and four emerging markets who experienced a crisis before (Malaysia, India, Korea, and Philippines). It is found that economic volatility, as measured by movement in inflation, output growth, and interest rate, have a weak predictor power for stock market volatility and returns. In line with the evidence reported in Davis and Kutan (2003), the findings suggest that there is no support for the Fisher effect in stock returns among the seven mature and emerging markets. Keywords: Predictive power; output; inflation; interest rate; stock return volatility.
Highlights
In conjunction with the financial crisis and the substantial variability in production levels, a question on the relationship between stock returns and economic activity arises (Mauro, 2000)
While previous studies have examined the relationship between macroeconomic factors and stock return volatility, there is no study on real output, inflation and interest rate together as exogenous variables in both the mean and conditional variance equations to simultaneously estimate the effect of these variables on stock market returns
This paper is the extension of Davis and Kutan’s (2003) study which employed Generalised Auto-Regressive Conditional Heteroscedasticity (GARCH) and exponential GARCH (EGARCH) models to simultaneously estimate the predictive power of real output and inflation on monthly stock returns and volatility using data from 13 countries
Summary
In conjunction with the financial crisis and the substantial variability in production levels, a question on the relationship between stock returns and economic activity arises (Mauro, 2000). While previous studies have examined the relationship between macroeconomic factors and stock return volatility, there is no study on real output, inflation and interest rate together as exogenous variables in both the mean and conditional variance equations to simultaneously estimate the effect of these variables on stock market returns. This paper is the extension of Davis and Kutan’s (2003) study which employed Generalised Auto-Regressive Conditional Heteroscedasticity (GARCH) and exponential GARCH (EGARCH) models to simultaneously estimate the predictive power of real output and inflation on monthly stock returns and volatility using data from 13 countries. The main purpose of this paper is to estimate the predictive power of output growth, inflation, and interest rate on monthly stock return and their conditional volatility using data from three mature markets (hereafter MM) and four Asia emerging markets (hereafter EM) to predict nominal stock returns. The result can be used to explain the volatility of stock market return and prove the validity of Fisher effect in international stock returns
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