Causality from real stock returns to real activity: evidence of regime-dependence

Angelos Kanas and Christos Ioannidis
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Angelos Kanas: Department of Economics, University of Crete, Greece, Postal: Department of Economics, University of Crete, Greece
Christos Ioannidis: University of Bath, UK, Postal: University of Bath, UK

International Journal of Finance & Economics, 2010, vol. 15, issue 2, 180-197

Abstract: We find strong evidence of regime switching in the relation between real stock prices and real activity for the UK over the period 1946-2002. Furthermore, there is evidence that the causality pattern from real stock returns to the IP growth rate varies across regimes: causality exists only in the low stock market volatility regime, while it does not exist in the high stock market volatility regime. As the latter largely refers to the period of inflation targeting in the UK, this finding uncovers the importance of monetary policy in insulating the real economy from unexpected financial market effects during periods of financial instability. Additional evidence of regime-dependence is uncovered using impulse response analysis. Finally, the US stock market is found to exercise significant regime-independent effects on the UK relation as a whole as well as on the future UK IP growth. Copyright © 2008 John Wiley & Sons, Ltd.

Date: 2010
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DOI: 10.1002/ijfe.383

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