McMillan D, Elgammal M & Ahmed F (2020) The Information Content of US Stock Market Factors. Studies in Economics and Finance, 37 (2), pp. 323-346. https://doi.org/10.1108/SEF-10-2019-0385
This paper considers the economic information content within several popular stock market factors and to the extent to which their movements are both explained by economic variables and can explain future output growth.
Using USA stock portfolios from 1964 to 2019, we undertake three related exercises: whether a set of common factors contain independent predictive ability for stock returns, what economic and market variables explain movements in the factors and whether stock market factors have predictive power for future output growth.
The results show that several of the considered factors do not contain independent information for stock returns. Further, most of these factors are not explained by economic conditions, nor they provide any predictive power for future output growth. Thus, they appear to contain very little economic content. However, the results suggest that the impact of these factors is more prominent with higher macroeconomic risk (contractionary regime).
The stock market factors are more likely to reflect existing market conditions and exhibit a weaker relation with economic conditions and do not act as a window on future behaviour.
Fama and French 3 factor model still have better explanations for stock returns and economic information more than any other model.
We contribute to the literature by examining whether a selection of factors provides unique information when modelling stock returns data. It also investigates what variables can predict movements in the stock market factors. Third, it examines whether the factors exhibit a link with subsequent economic output. This should establish whether the stock market factors contain useful information for stock returns and the macroeconomy or whether the significance of the factor is a result of chance. The results in this paper should advance our understanding of asset price movement and the links between the macroeconomy and financial markets and thus be of interest to academics, investors and policymakers.
Stock Market Factors; GDP Growth; Predictability; Macro economic risk; Asset Pricing
Studies in Economics and Finance: Volume 37, Issue 2