Abstract
This study investigates the stock price–economic activity nexus in 12 member countries of the Organization for Economic Cooperation and Development (OECD) by employing monthly data over the period 1981:1–2018:3. For this purpose, the study uses Granger causality in the frequency domain in the panel setting by decomposing the symmetric and asymmetric fluctuations. This methodology determines whether the predictive power of interested variables is concentrated on quickly, moderately, or slowly fluctuating components. Our findings show that the stock prices have predictive power for future long-term economic activity in the panel setting. However, economic activity has more reliable information for stock prices for negative components. Additionally, empirical findings for asymmetric shocks are not fully consistent with those of symmetric ones. Besides, the country-specific results provide different causal linkages across members and frequencies. These findings may provide valuable information for policymakers to design proper and effective policies in OECD countries regarding the stock market and economic activity nexus.
Highlights
In recent years, a growing number of researchers and policymakers have attempted to clarify whether stock markets convey relevant information for future economic activity or vice versa
The empirical findings of this study indicate that stock prices have the predictive power for future economic activity in the long-term, while its causal impact is statistically insignificant in the remaining frequencies
In the long term, which corresponds to 12.5 months, there is a bidirectional relationship between the stock price index and industrial production index (IPI) regarding symmetric shocks
Summary
A growing number of researchers and policymakers have attempted to clarify whether stock markets convey relevant information for future economic activity or vice versa. The very first discussions of the relationship between stock market prices and real economic activity emerged during the 1960s and 1970s with preliminary studies by Goldsmith (1969), Bosworth (1975), and Hall (1978). The existing body of theoretical literature suggests that there are four main theories that explain the predictive performance of stock market prices for future economic growth: (1) discounted-cash-flow model; (2) wealth channel; (3) Tobin’s Q channel; and (4) the financial accelerator theory. If stock prices are related to fundamentals, they lead to real activity measures (Kim and In 2003). The vital role of forward-looking stock prices in forecasting the subsequent growth rates of real economic activity breaks down if stock market booms arise from speculative bubbles (Binswanger 2004)
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