Stock Returns and Changes in the Business Cycle

Abstract

This study employs the production asset pricing model of Brock (1982) to examine whether changes in the business cycle can be predicted, and whether there exists a link between stock returns and forecasted changes in the business cycle. The gross domestic product (GDP) and industrial production (IP) are used as the proxies for the business cycle. The predictability of changes in the business cycle and the equilibrium relationship between stock returns and forecasted changes in the business cycle are illustrated by results using IP data in Taiwan over the period from 1972 to 2000. Nonetheless, empirical findings using GDP data show that changes in GDP are not predicable until recent period of time, and moreover, there is no link between stock returns and forecasted changes in GDP.