The Nonlinear Multidimensional Relationship Between Stock Returns and the Macroeconomy

The Nonlinear Multidimensional Relationship Between Stock Returns and the Macroeconomy. Chen, P. & Smith, A. Applied Economics, 45(35):4985–4999, Routledge, 2013.

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We use nonparametric dimension-reduction methods to extract from a set of 15 macroeconomic variables the risk factors that are priced in the stock market. The dominant factor moves with the business cycle but, because it is a nonlinear function of observed macroeconomic variables, it captures a rich set of interactions. Low-credit risk and low-inflationary expectations have a greater positive effect on stock returns when leading macroeconomic indicators are high relative to current economic activity, i.e. early in the business cycle as the economy emerges from recession. High-stock returns also arise in periods when the economy is booming relative to its leading indicators, but such periods tend to portend crashes.

@article{chen2013nonlinear,
  title={The Nonlinear Multidimensional Relationship Between Stock Returns and the Macroeconomy},
  author={Chen, Pian and Smith, Aaron},
  journal={Applied Economics},
  volume={45},
  number={35},
  pages={4985--4999},
  year={2013},
	url={https://files.asmith.ucdavis.edu/2013_AE_CS_SIR.pdf},
	keywords={finance},
	abstract={We use nonparametric dimension-reduction methods to extract from a set of 15 macroeconomic variables the risk factors that are priced in the stock market. The dominant factor moves with the business cycle but, because it is a nonlinear function of observed macroeconomic variables, it captures a rich set of interactions. Low-credit risk and low-inflationary expectations have a greater positive effect on stock returns when leading macroeconomic indicators are high relative to current economic activity, i.e. early in the business cycle as the economy emerges from recession. High-stock returns also arise in periods when the economy is booming relative to its leading indicators, but such periods tend to portend crashes.},
  publisher={Routledge}
}

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