Return and Volatility Connectedness between Stock Markets and Macroeconomic Factors in the G-7 Countries

Abstract

We examine the relationship between return and volatility of the stock markets and macroeconomic fundamentals for the G-7 countries by using monthly data ranging from July 1985 to June 2015. To meet this end, we apply the spillover index approach based on the generalized VAR framework developed by Diebold and Yilmaz (2012, 2014). The empirical analysis shows strong interactions between the returns and volatilities of the G-7 stock markets and the considered set of corresponding macroeconomic factors including industrial production, money supply, interest rates, inflation, oil prices and exchange rates. The return and volatility spillover transmission/reception dynamics of the relationships between these stock markets and the macroeconomic fundamentals have changed after the global financial crisis of 2008. Our findings provide useful insights for investors and policy makers concerned with the unprecedented swings in the stock markets of G-7 countries.

Keywords

G-7 return / volatility / connectedness / macroeconomic factors / generalized VAR

References

[1] Abbas G, McMillan DG. Interaction among stock prices and monetary variables in Pakistan. International Journal of Monetary Economics and Finance, 2014, 7(1): 13-27.

[2] Abdullah DA, Hayworth SC. Macroeconometrics of stock price fluctuations, 1993

[3] Abouwafia HE, Chambers MJ. Monetary policy, exchange rates, stock prices in the Middle East region. International Review of Economics and Finance, 2015, 37(3): 14-28.

[4] Adjasi CK. Macroeconomic uncertainty and conditional stock–price volatility in frontier African markets: Evidence from Ghana. The Journal of Risk Finance, 2009, 10(4): 333-349.

[5] Aloui C, Jammazi R. The effects of crude oil shocks on stock market shifts behaviour:^A regime switching approach. Energy Economics, 2009, 31(5): 789-799.

[6] Arnold IJ, Vrugt EB. Stock market volatility and macroeconomic uncertainty: Evidence from survey data, 2006

[7] Awartani B, Maghyereh AI, Al Shiab M. Directional spillovers from the^US and the Saudi market to equities in the Gulf Cooperation Council countries. Journal of International Financial Markets, Institutions and Money, 2013, 27(6): 224-242.

[8] Beltratti A, Morana C. Breaks and persistency: macroeconomic causes of stock market volatility. Journal of Econometrics, 2006, 131(1): 151-177.

[9] Bollerslev T. Generalized autoregressive conditional heteroskedasticity. Journal of Econometrics, 1986, 31(3): 307-327.

[10] Boons M. State variables, macroeconomic activity, and the cross section of individual stocks. Journal of Financial Economics, 2016, 119(3): 489-511.

[11] Boudoukh J, Richardson M. Stock returns and inflation:^A long–horizon perspective. The American Economic Review, 1993, 83(5): 1346-1355.

[12] Branson WH. Macroeconomic determinants of real exchange risk, 1983, Cambridge: Cambridge University Press

[13] Brooks C. Introductory Econometrics for Finance, 2014, Cambridge: Cambridge University Press.

[14] Chan L, Lien D, Weng W. Financial interdependence between Hong Kong and the US:^A band spectrum approach. International Review of Economics & Finance, 2008, 17(4): 507-516.

[15] Chaudhuri K, Smiles S. Stock market and aggregate economic activity: evidence from Australia. Applied Financial Economics, 2004, 14(2): 121-129.

[16] Chen NF, Roll R, Ross SA. Economic forces and the stock market, 1986.

[17] Chinzara Z. Macroeconomic uncertainty and conditional stock market volatility in South Africa. South African Journal of Economics, 2011, 79(1): 27-49.

[18] Choudhry T, Papadimitriou FI, Shabi S. Stock market volatility and business cycle: Evidence from linear and nonlinear causality tests. Journal of Banking and Finance (In press), 2016

[19] Chowdhury S, Rahman M. Ontheempirical relation between macroeconomic volatility and stock market volatility of Bangladesh. The Global Journal of Finance and Economics, 2004, 1(2): 209-225.

[20] Corradi V, Distaso W, Mele A. Macroeconomic determinants of stock market volatility and volatility risk–premiums, 2012.

[21] Cumming DJ, MacIntosh JG. Crowding out private equity: Canadian evidence. Journal of BusinessVenturing, 2006, 21: 569-609.

[22] Darrat A, Dickens R. On the interrelationships among real, monetary, and financial variables. Applied Financial Economics, 1999, 9(3): 289-293.

[23] Diaz EM, Molero JC, de Gracia FP. Oil price volatility and stock returns in the G7 economies. Energy Economics, 2016, 54: 417-430.

[24] Diebold FX, Yilmaz K. Macroeconomic volatility and stock market volatility, worldwide. National Bureau of Economic Research, 2007

[25] Diebold FX, Yilmaz K. Measuring Financial Asset Return and Volatility Spillovers, with Application to Global Equity Markets. The Economic Journal, 2009, 119(534): 158-171.

[26] Diebold FX, Yilmaz K. Better to give than to receive: Predictive directional measurement of volatility spillovers. International Journal of Forecasting, 2012, 28(1): 57-66.

[27] Diebold FX, Yilmaz K. On the network topology of variance decompositions: Measuring the connectedness of financial firms. Journal of econometrics, 2014, 182(1): 119-134.

[28] Diebold FX, Yilmaz K. Financial and Macroeconomic Connectedness:^A Network Approach to Measurement and Monitoring, 2015.

[29] Diebold FX, Yilmaz K. Trans–Atlantic equity volatility connectedness:^US and European financial institutions, 2004–2014. Journal of Financial Econometrics, 2015, 14(1): 81-127.

[30] Dimpfl T. The impact of^US news on the German stock market: An event study analysis. The Quarterly Review of Economics and Financial Economics, 2011, 15(14): 987-994.

[31] Dornbush R, Fisher S. Exchange rate and the current account. The American Economic Review, 1980, 70: 960-971.

[32] Engle RF. Autoregressive conditional heteroscedasticity with estimates of the variance of United Kingdom inflation. Econometrica, 1982, 50(4): 987-1007.

[33] Erdem C, Arslan CK, Sema Erdem M. Effects of macroeconomic variables on Istanbul stock exchange indexes. Applied Financial Economics, 2005, 15(14): 987-994.

[34] Ewing BT, Malik F. Volatility spillovers between oil prices and the stock market under structural breaks. Global Finance Journal, 2015, 29: 12-23.

[35] Fama EF. Stock returns, real activity, inflation, and money. The American Economic Review, 1981, 71(4): 545-565.

[36] Fama EF. Stock returns, expected returns and real activity. Journal of Finance, 1990, 45(4): 1089-1108.

[37] Fengler MR, Gisler KI. A variance spillover analysis without covariances: What do we miss. Journal of International Money and Finance, 2015, 51(2): 174-195.

[38] Frankel J. Monetary and portfolio model of exchange rate determination.In J, 1983

[39] French KR, Schwert GW, Stambaugh RF. Expected stock returns and volatility. Journal of Financial Economics, 1987, 19(1): 3-29.

[40] Gan C, Lee M, Yong HHA, Zhang J. Macroeconomic variables and stock market interactions: New Zealand evidence. Investment Management and Financial Innovations, 2006, 3(4): 89-101.

[41] George LY. The interactions between China and^US stock markets: Newperspectives. Journal of International Financial Markets, Institutions and Money, 2014, 31: 331-342.

[42] Giglio S, Kelly B, Pruitt S. Systemic risk and the macroeconomy: An empirical evaluation, 2016

[43] Gjerde S, Saettem F. Causal relations among stock returns and macroeconomic variables in a small, open economy. Journal of International Financial Markets, Institutions and Money, 1999, 9(1): 61-74.

[44] Gunasekarage A, Pisedtasalasai A, Power DM. Macroeconomic influence on the stock market: evidence from an emerging market in South Asia. Journal of Emerging Market Finance, 2004, 3(3): 285-304.

[45] Hashemzadeh N, Taylor P. Stock prices, money supply, and interest rates: the question of causality. Applied Economics, 1988, 20(12): 1603-1611.

[46] Hsing Y, Hsieh W. Impacts of macroeconomic variables on the stock market index in Poland: new evidence. Journal of Business Economics and Management, 2012, 13(2): 334-343.

[47] Karunanayake I, Valadkhani A, O’Brien M. Modelling Australian stock market volatility: a multivariate GARCH approach. University of Wollongong, 2009

[48] Kilian L, Park C. The impact of oil price shocks on the^US stock market. International Economic Review, 2009, 50(4): 1267-1287.

[49] Koop G, Pesaran HM, Potter SM. Impulse response analysis in nonlinear multivariate models. Journal of Econometrics, 1996, 74: 119-147.

[50] Kumari J, Mahakud J. Relationship between conditional volatility of domestic macroeconomic factors and conditional stock market volatility: Some further evidence from India. Asia–Pacific Financial Markets, 2015, 22(1): 87-111.

[51] Lai S, Cheng TY, Li HC, Chien SP. Dynamic interactions among macroeconomic variables and stock indexes in Taiwan, Hong Kong, and China. Emerging Markets Finance and Trade, 2013

[52] Liljeblom E, Stenius M. Macroeconomic volatility and stock market volatility: empirical evidence on Finnish data. Applied Financial Economics, 1997, 7(4): 419-426.

[53] Malliaris AG, Urrutia JL. An empirical investigation among real, monetary and financial variables. Economics Letters, 1991, 37(2): 151-158.

[54] Manda K. Stock market volatility during the 2008 financial crisis, 2010

[55] Martens M, Zein J. Predicting financial volatility: High frequency time series forecasts vis–a–vis implied volatility. Journal of Futures Markets, 2004, 24(11): 1005-1028.

[56] Maysami RC, Howe LC, Hamzah MA. Relationship between macroeconomic variables and stock market indices: cointegration evidence from stock exchange of Singapore’s all–S sector indices. Jurnal Pengurusan, 2004, 24(1): 47-77.

[57] Mookerjee R, Yu Q. Macroeconomic variables and stock prices in a small open economy: The case of Singapore. Pacific–Basin Finance Journal, 1997, 5(3): 377-388.

[58] Morelli D. The relationship between conditional stock market volatility and conditional macroeconomic volatility: Empirical evidence based on^UK data. International Review of Financial Analysis, 2002, 11(1): 101-110.

[59] Moussa D, Zhang WJ. Modeling jumps in returns of financial assets as M4 processes: Measured exchange rate exposure of Asian equity portfolio. Journal of Systems Science and Systems Engineering, 2005, 14(3): 364-380.

[60] Mukherjee TK, Naka A. Dynamic relations between macroeconomic variables and the Japanese stock market: an application of a vector error correction model. Journal of Financial Research, 1995, 18(2): 223-237.

[61] Officer RR. The variability of the market factor of the New York Stock Exchange. The Journal of Business, 1973, 46(3): 434-453.

[62] Papapetrou E. Oil price shocks, stock market, economic activity and employment in Greece. Energy Economics, 2001, 23(5): 511-532.

[63] Park J, Ratti RA. Oil price shocks and stock markets in the^US and 13 European countries. Energy Economics, 2008, 30(5): 2587-2608.

[64] Pesaran HH, Shin Y. Generalized impulse response analysis in linear multivariate models. Economics Letters, 1998, 58(1): 17-29.

[65] Qiao KJ. Government policies and corporate financing decisions in China: Theory and evidence. Journal of Systems Science and Systems Engineering, 2013, 22(1): 93-111.

[66] Rahman M, Ashraf MM. Influences ofmoney supply and oil price on^US stock market, 2008

[67] Ratanapakorn O, Sharma SC. Dynamic analysis between the^US stock returns and the macroeconomic variables. Applied Financial Economics, 2007, 17(5): 369-377.

[68] Sadorsky P. Oil price shocks and stock market activity. Energy Economics, 1999, 21(5): 449-469.

[69] Sadorsky P. The macroeconomic determinants of technology stock price volatility. Review of Financial Economics, 2003, 12(2): 191-205.

[70] Schwert GW. Why does stock market volatility change over time. The Journal of Finance, 1989, 44(5): 1115-1153.

[71] Schwert GW. Stock volatility during the recent financial crisis. European Financial Management, 2011, 17(5): 789-805.

[72] Sellin P. Monetary policy and the stock market: theory and empirical evidence. Journal of Economic Surveys, 2001, 15(4): 491-541.

[73] Serletis A. Money and stock prices in the United States. Applied Financial Economics, 1993, 3(1): 51-54.

[74] Shafiei E, Ghofrani MB, Saboohi YJ. Journal of Systems Science and Systems Engineering, 2009, 18(3): 312-340.

[75] Su Z, Ma J, Wohar ME. Sources of the stock price fluctuations in Chinese equity market. The European Journal of Finance, 2014, 20(7): 829-846.

[76] Thornton J. Money, output and stock prices in the UK: Evidence on some (non) relationships. Applied Financial Economics, 1993, 3(4): 335-338.

[77] Thornton J. Real stock prices and the long–run demand for money in Germany. Applied Financial Economics, 1998, 8(5): 513-517.

[78] Wang GJ, Xie C, Jiang ZQ, Stanley HE. Who are the net senders and recipients of volatility spillovers in China’s financial markets. Finance research letters, 2016, 18(3): 255-262.

[79] Zhang B, Li XM. Has there been any change in the comovement between the Chinese and^US stock markets. International Review of Economics & Finance, 2014, 29(1): 525-536.

[80] Zhang B, Wang P. Return and volatility spillovers between china and world oil markets. Economic Modelling, 2014, 42(7): 413-420.

[81] Zhou X, Zhang W, Zhang J. Volatility spillovers between the Chinese and world equity markets. Pacific–Basin Finance Journal, 2012, 20(2): 247-270.