BUSINESS CYCLES AND STOCK MARKET RETURNS: EVIDENCE USING INDUSTRY-BASED PORTFOLIOS

Much evidence has emerged recently that suggests stock returns are predictable. In representative agent consumption-based asset pricing models, asset returns are related to aggregate output and consumption through changes in the intertemporal marginal rate of substitution. An alternative view is that the amount of variation required in the intertemporal marginal rate of substitution is too large to be rationally explained. We shed further light on this debate by investigating whether the stock returns of certain sectors of the economy can predict future market returns even after controlling for the information contained in the aggregate market index. In the consumption-based models, aggregate output and consumption affect the discount rates of all assets synchronously; no particular sectoral return should have any more predictive ability than the others. We find evidence that the stock returns of five industry-based portfolios have significant information about future market returns that is not in the market index. This stylized empirical result is not consonant with existing models relating output to stock returns.     

Testing for negative expected market return premia

This paper tests the hypothesis that the expected return premium on the market portfolio is always non-negative. A violation of this lower bound restriction provides evidence against a broad class of risk-based equilibrium models in favor of bubble behavior. Our tests utilize information variables, identified in prior literature, that predict time variation in market return premia. We employ out-of-sample forecasts and bootstraps generated with parameters that are consistent with non-negativity but closest to the estimated parameters. We find statistically reliable evidence against non-negativity for the excess return on the value-weighted market index. The most negative out-of-sample prediction was −2.01% in September 1973.     

The Impact of Legal and Political Institutions on Equity Trading Costs: A Cross-Country Analysis

We conjecture that macro-level institutions affect equity tradingcosts through their impact on information risk and investorparticipation. In a study of trading costs for 412 NYSE-listedAmerican Depository Receipts (ADRs) from 44 countries, we findthat, after controlling for firm-level determinants of tradingcosts, effective spreads and price impact of trades are significantlylower for stocks from countries with better ratings for judicialefficiency, accounting standards, and political stability. Tradingcosts are significantly higher for stocks from French civillaw countries than from common law countries. Overall, we concludethat improvements in legal and political institutions will lowerthe cost of liquidity in financial markets.     

Cross-sectional determinants of New Zealand share market returns

We present evidence of the cross-sectional relation between security returns, beta, firm size and book-to-market ratio over the period 1971 to 1993 on the New Zealand sharemarket. Our results suggest that the NZSE-40 market index is not a mean-variance efficient market proxy—the betas calculated with respect to it being of little use for explaining expected returns cross-sectionally. Also, there is a significant positive relation between book-to-market ratio and average return.