What does the tail of the distribution of current stock prices tell us about future economic activity?

Abstract

AbstractThis paper proposes three leading indicators of economic conditions estimated using current stock returns. The assumption underlying our approach is that current asset prices reflect all the available information about future states of economy. Each of the proposed indicators is related to the tail of the cross‐sectional distribution of stock returns. The results show that the leading indicators have strong correlation with future economic conditions and usually make better out‐of‐sample predictions than two traditional competitors (random walk and the average of previous observations). Furthermore, quantile regressions reveal that the leading indicators have strong connections with low future economic activity.