Are the dynamic linkages between the macroeconomy and asset prices time-varying?

Massimo Guidolin and Sadayuki Ono

No 2005-056, Working Papers from Federal Reserve Bank of St. Louis

Abstract: We estimate a number of multivariate regime switching VAR models on a long monthly data set for eight variables that include excess stock and bond returns, the real T-bill yield, predictors used in the finance literature (default spread and the dividend yield), and three macroeconomic variables (inflation, real industrial production growth, and a measure of real money growth). Heteroskedasticity may be accounted for by making the covariance matrix a function of the regime. We find evidence of four regimes and of time-varying covariances. We provide evidence that the best in-sample fit is provided by a four state model in which the VAR(1) component fails to be regime-dependent. We interpret this as evidence that the dynamic linkages between financial markets and the macroeconomy have been stable over time. We show that the four-state model can be helpful in forecasting applications and to provide one-step ahead predicted Sharpe ratios.

Keywords: Macroeconomics; Asset pricing (search for similar items in EconPapers)
Date: 2005
New Economics Papers: this item is included in nep-for, nep-mac and nep-rmg
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Citations: View citations in EconPapers (1)

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Journal Article: Are the dynamic linkages between the macroeconomy and asset prices time-varying? (2006)
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DOI: 10.20955/wp.2005.056

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