Abstract
PurposeThe purpose of this paper is to consider the economic information content within several popular stock market factors and to the extent to which their movements are both explained by economic variables and can explain future output growth.Design/methodology/approachUsing US stock portfolios from 1964 to 2019, the authors undertake three related exercises: whether a set of common factors contain independent predictive ability for stock returns, what economic and market variables explain movements in the factors and whether stock market factors have predictive power for future output growth.FindingsThe results show that several of the considered factors do not contain independent information for stock returns. Further, most of these factors are neither explained by economic conditions nor they provide any predictive power for future output growth. Thus, they appear to contain very little economic content. However, the results suggest that the impact of these factors is more prominent with higher macroeconomic risk (contractionary regime).Research limitations/implicationsThe stock market factors are more likely to reflect existing market conditions and exhibit a weaker relation with economic conditions and do not act as a window on future behavior.Practical implicationsFama and French three-factor model still have better explanations for stock returns and economic information more than any other models.Originality/valueThis paper contributes to the literature by examining whether a selection of factors provides unique information when modelling stock returns data. It also investigates what variables can predict movements in the stock market factors. Third, it examines whether the factors exhibit a link with subsequent economic output. This should establish whether the stock market factors contain useful information for stock returns and the macroeconomy or whether the significance of the factor is a result of chance. The results in this paper should advance our understanding of asset price movement and the links between the macroeconomy and financial markets and, thus, be of interest to academics, investors and policy-makers.
Highlights
In understanding asset price behaviour, current research typically forms portfolios based on some firm characteristic, measure of value or past stock returns
It investigates what variables can predict movements in the stock market factors. It examines whether the factors exhibit a link with subsequent economic output. This should establish whether the stock market factors contain useful information for stock returns and the macroeconomy or whether the significance of the factor is a result of chance
In linking the stock market factors with macroeconomic variables, we find both only limited evidence that the risk factors can be explained by economic variables and that the factors exhibit any predictive power for subsequent economic growth
Summary
This paper considers the economic information content within several popular stock market factors and to the extent to which their movements are both explained by economic variables and can explain future output growth. The results show that several of the considered factors do not contain independent information for stock returns Most of these factors are not explained by economic conditions, nor they provide any predictive power for future output growth. We contribute to the literature by examining whether a selection of factors provides unique information when modelling stock returns data. It investigates what variables can predict movements in the stock market factors. It examines whether the factors exhibit a link with subsequent economic output This should establish whether the stock market factors contain useful information for stock returns and the macroeconomy or whether the significance of the factor is a result of chance. The results in this paper should advance our understanding of asset price movement and the links between the macroeconomy and financial markets and be of interest to academics, investors and policymakers
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