Stock Market Efficiency and the Federal Budget Deficit: Another Anomaly?

This paper investigates the efficiency of the U.S. stock market as it pertains to a number of major macrofinance variables that theory and empirical evidence suggest are important in rational stock pricing decisions. A multivariate vector autoregressive analysis is used to draw efficiency inferences. The estimated factor pricings are consistent with theory and previous empirical research. In addition, these results indicate that the stock market may be inefficient with respect to the federal budget deficit variable. Similar apparent inefficiency evidence is obtained for the term structure and risk premium variables. The authors cannot reject the efficiency hypothesis for industrial production, inflation, and base money. Using indirect causality tests, the authors find plausible intermediate information linkages connecting variables in the system. The term structure and risk premia variables consistently appear important as intermediate conduits through which information about other factors impact stock returns.