How macroeconomic factors affect stock returns
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examine how macroeconomic factors affect stock returns.
Order Instructions:
The goal of the project: We examine how macroeconomic factors affect stock returns.
Empirically, we can test the following model;
Rt= ?0 + ?1*Market Indext-1+ ?2*Inflationt-1+ ?3*GDP Growtht-1+ ?4*TERMt-1+ ?5*RISKt-1+?
1. Dependent variable: firms’ stock returns
I posted firms’ stock returns in three industries (air, auto, and computer) to Blackboard. You can analyze any firm as you wish. You can pick multiple firms from three different industries, or a single firm from a specific industry.
Variable Explanations
DATE: the end of trading date at each month
COMNAM: Company name
EXCHCD: Exchange code (1: NYSE, 2: AMEX, and 3:NASDAQ)
HSICCD: Industry classification (e.g., The SIC 4512 represents an airline industry.
PRC: Stock price at the end of each month’s trading date
RET: Stock returns at the end of each month’s trading date
SHROUT: shares outstanding
VWRETD: Market index
2. Independent variables: macroeconomic variables
* The Source of data: http://research.stlouisfed.org/fred2/tags/series
Download data as long as we believe that variables may affect stock returns.
There are some candidates for independent variables.
Market Index=VWRETD, and Firm Size= PRC*SHROUT
Inflation= log (CPIt / CPIt-1), and GDP Growth=log (GDPt / GDPt-1)
TERM= 10-year T/B – 3-month T/B, and RISK= BAAt – 10-year T/B?
Questions
1) Report summary statistics (n, mean, median, standard deviation, min, max) of your picked variables.
2)Why do you include such independent variables? Give me a brief explanation.
3) Run a regression and report coefficients and t-statistics for the explanatory variables.
4) Interpret coefficients of each variable. Compare it with your prediction
5) What is your investment strategy based on your findings?
* To obtain full credit (20 points), you need to submit it by July 8th, 2014.Grade below 10 points will be counted as zero.
* The minimum requirement is 5 different firms and 5 independent variables.
* TERM and RISK should be included as independent variables.
* If you need a reference, please look at the paper written by Nai-Fu Chen, Richard Roll, and Stephen A. Ross. The title is “Economic Forces and the Stock Market (Journal of Business, 1986)”.
SAMPLE ANSWER
How macroeconomic factors affect stock returns
Abstract
There are many macroeconomic factors that affect the stock market globally. Inflation and deflation have adverse financial effects on a company’s profitability which subsequently affect the stock market. The rate of increment on the prices of goods and other services constitutes inflation besides the increase in the cost of transportation and manufacturing expenses. (Swann, 2009) The stock market responds powerfully when the rate of inflation is low and weakens when it increases as most companies reduce their expenditures because of high cost of goods and services and the general money in economy reduces which results in reduced activities at the stock market. Deflation in most quarters is regarded as a sign of a weak economy as it also leads to a decrease in the stock market. (Chen, Roll and Ross, 1986)
The interest rates are established and monitored by Federal Reserve Board. Higher rates of interests are caused by the expensive nature of borrowing money. Money becomes too expensive to borrow. To subsidize their high rates of interests, most companies may opt to lay off workers and reduce expenditures on other goods. Higher rates of interests imply that even companies will not be comfortable when borrowing as the rate of interests becomes exorbitant and their income will also be affected. (Cairns, 2004) When the income of listed companies reduces then the investments in the stock market is also affected negatively.
1
Sun Microsystems | ||||
PRC | RET | SHROUT | WRETD | |
n | 132 | 132 | 133 | 133 |
Mean | 22.36021 | 0.001747 | 2447123 | 0.002766 |
Median | 114.34 | -0.08963 | 955344.5 | -0.184 |
STD | 34.098 | 0.16257 | 1201797 | 0.048607 |
Min | 2.59 | -0.39474 | 385583 | -0.18462 |
Max | 132.25 | 0.564103 | 3602000 | 0.110533 |
FRANKLIN ELCTRONIC PUBLISHS | ||||
PRC | RET | SHROUT | WRETD | |
n | 133 | 133 | 134 | 134 |
Mean | 3.182147 | 0.013589 | 8063.91 | 0.003009 |
Median | 9.445006 | 0.066578 | 8504.844 | 0.053974 |
STD | 4.080006 | 0.21349 | 402.3438 | 0.053359 |
Min | -3.845 | -0.46429 | 7818 | -0.18462 |
Max | 11.9375 | 1.141434 | 8387 | 0.110533 |
SILICON GRAPHICS INC | ||||
PRC | RET | SHROUT | WRETD | |
n | 82 | 82 | 83 | 83 |
Mean | 4.081159 | 0.025353 | 211362.6 | 0.003827 |
Median | 14.69741 | 0.253384 | 439218.6 | 0.012599 |
STD | 14.06612 | 0.521925 | 57156.86 | 0.041823 |
Min | 0.44 | -0.54676 | 182872 | -0.10253 |
Max | 20.5625 | 2.782609 | 268272 | 0.083911 |
APPLE COMPUTER INC | ||||
PRC | RET | SHROUT | WRETD | |
n | 96 | 96 | 96 | 96 |
Mean | 43.137 | 0.035008 | 438980.5 | 0.004941 |
Median | 63.01375 | -0.03415 | 498318.5 | 0.024586 |
STD | 30.86698 | 0.056931 | 511806 | 0.019459 |
Min | 14.14 | -0.57744 | 136417 | -0.10253 |
Max | 135.8125 | 0.453782 | 860220 | 0.083911 |
UAL CORP | ||||
PRC | RET | SHROUT | WRETD | |
n | 51 | 51 | 52 | 52 |
Mean | 36.4751 | -0.05963 | 56649.73 | -0.00232 |
Median | 62.25 | 0.042932 | 74327 | 0.060554 |
STD | 43.42343 | 0.187492 | 32795.61 | 0.019813 |
Min | 0.84 | -0.51765 | 49792 | -0.10253 |
Max | 80.75 | 0.326258 | 99506 | 0.083911 |
FORD MOTOR CO | ||||
PRC | RET | SHROUT | WRETD | |
n | 144 | 144 | 144 | 144 |
Mean | 17.04726 | 0.009958 | 1961721 | 0.004096 |
Median | 39.11375 | 0.054011 | 2270481 | 0.053095 |
STD | 31.57055 | 0.00097 | 1599931 | 0.02086 |
Min | 16.79 | 0.053325 | 1139159 | 0.038345 |
Max | 63.9375 | 1.273764 | 3401803 | 0.110533 |
- Independent variables are included as they determine or influence other variables. An independent variable when manipulated determines or influences the change in the other dependent variable. This study seeks to determine if a relationship exists between the returns of the stock market and the macro economic factors that may affect the overall performance of the stock market.
- Ford Motor Co
SUMMARY OUTPUT | ||||||||
Regression Statistics | ||||||||
Multiple R | 0.4995218 | |||||||
R Square | 0.249522 | |||||||
Adjusted R Square | 0.244237 | |||||||
Standard Error | 0.148835 | |||||||
Observations | 144 | |||||||
ANOVA | ||||||||
df | SS | MS | F | Significance F | ||||
Regression | 1 | 1.04585 | 1.04585 | 47.213 | 1.849E-10 | |||
Residual | 142 | 3.14556 | 0.02215 | |||||
Total | 143 | 4.19142 | ||||||
Coefficient | Standard error | t Stat | P-value | Lower 95% | Upper 95% | Lower 95.0% | Upper 95.0% | |
Intercept | 0.0029 | 0.0124 | 0.2290 | 0.8192 | -0.0218 | 0.0275 | -0.0218 | 0.0275 |
VWRETD | 1.7354 | 0.2526 | 6.8712 | 0.0000 | 1.2361 | 2.2347 | 1.2361 | 2.2347 |
Franklin Electronic Publish Inc
SUMMARY OUTPUT | ||||||||
Regression Statistics | ||||||||
Multiple R | 0.31 | |||||||
R Square | 0.09 | |||||||
Adjusted R Square | 0.09 | |||||||
Standard Error | 0.23 | |||||||
Observations | 133.00 | |||||||
ANOVA | ||||||||
df | SS | MS | F | Sig F | ||||
Regression | 1 | 0.715 | 0.715 | 13.554 | 0.000 | |||
Residual | 131 | 6.915 | 0.053 | |||||
Total | 132 | 7.631 | ||||||
Coeff | Std Error | t Stat | P-value | Lower 95% | Upper 95% | Lower 95.0% | Upper 95.0% | |
Intercept | 0.0094 | 0.019955 | 0.47106 | 0.6383832 | -0.03 | 0.048876 | -0.03008 | 0.048876 |
VWRETD | 1.5147 | 0.411416 | 3.68157 | 0.0003377 | 0.7008 | 2.328532 | 0.700776 | 2.328532 |
UAL Corp
SUMMARY OUTPUT | ||||||||
Regression Statistics | ||||||||
Multiple R | 0.552 | |||||||
R Square | 0.304 | |||||||
Adjusted R Square | 0.290 | |||||||
Standard Error | 0.156 | |||||||
Observations | 51.000 | |||||||
ANOVA | ||||||||
df | SS | MS | F | Sign f | ||||
Regression | 1 | 0.521 | 0.521 | 21.442 | 0.000 | |||
Residual | 49 | 1.191 | 0.024 | |||||
Total | 50 | 1.712 | ||||||
Coeff | Std error | t Stat | P-value | Lower 95% | Upper 95% | Lower 95.0% | Upper 95.0% | |
Intercept | -0.052 | 0.022 | -2.372 | 0.022 | -0.096 | -0.008 | -0.096 | -0.008 |
VWRETD | 1.933 | 0.418 | 4.631 | 0.000 | 1.094 | 2.772 | 1.094 | 2.772 |
Sun Microsystems
Regression Statistics | ||||||||
Multiple R | 0.664 | |||||||
R Square | 0.441 | |||||||
Adjusted R Square | 0.437 | |||||||
Standard Error | 0.122 | |||||||
Observations | 132.000 | |||||||
ANOVA | ||||||||
df | SS | MS | F | Significance F | ||||
Regression | 1 | 1.527 | 1.527 | 102.6 | 3.92E-18 | |||
Residual | 130 | 1.935 | 0.015 | |||||
Total | 131 | 3.462 | ||||||
Coeffici | Std Error | t Stat | P-value | Lower 95% | Upper 95% | Lower 95.0% | Upper 95.0% | |
Intercept | -0.005 | 0.011 | -0.476 | 0.635 | -0.026 | 0.016 | -0.026 | 0.016 |
VWRETD | 2.219 | 0.219 | 10.130 | 0.000 | 1.785 | 2.652 | 1.785 | 2.652 |
Silicon
Regression Statistics | ||||||||
Multiple R | 0.260 | |||||||
R Square | 0.067 | |||||||
Adjusted R Square | 0.056 | |||||||
Standard Error | 0.403 | |||||||
Observations | 82.00 | |||||||
ANOVA | ||||||||
df | SS | MS | F | Sig F | ||||
Regression | 1 | 0.939 | 0.939 | 5.787 | 0.018 | |||
Residual | 80 | 12.97 | 0.162 | |||||
Total | 81 | 13.91 | ||||||
Coe | Std error | t Stat | P-value | Lower 95% | Upper 95% | Lower 95.0% | Upper 95.0% | |
Intercept | 0.017 | 0.045 | 0.391 | 0.697 | -0.071 | 0.106 | -0.071 | 0.106 |
VWRETD | 2.338 | 0.972 | 2.406 | 0.018 | 0.404 | 4.272 | 0.404 | 4.272 |
- Interpretation
Ford Motor Co.
The thesis of the study is to establish if a relationship exists between the performance of individual stocks belonging to different companies and the performance of the stock market and if the stock market can be affected by macroeconomic factors such as real GDP growth, inflation, interest rates or unemployment.
P-Value – 0.8192 It indicates that the significant relationship between the returns of the market and the performance of the markets index is very low.
Coefficient – 1.7354 The slope is of the graph is positive which indicates that the stock returns increases relatively to the increase in the stock index.
R square – 0.2495 The R square measures the strength of the relationship, how strong or weak the relationship is. In this case we can conclude that the variability of the stock market index explains only 24.95% of the stock returns.
Franklin Electronic Publish Inc
P-Value – 0.6383 It indicates that the significant relationship between the returns of the market and the performance of the markets index is very low.
Coefficient – 1.514 The slope is of the graph is positive which indicates that the stock returns increases relatively to the increase in the stock index.
R square – 0.09 The R square measures the strength of the relationship, how strong or weak the relationship is. In this case we can conclude that the variability of the stock market index explains only 9 % of the stock returns.
UAL Corp
P-Value – 0.022 It indicates that the significant relationship between the returns of the market and the performance of the markets index is very low.
Coefficient – 1.933 The slope is of the graph is positive which indicates that the stock returns increases relatively to the increase in the stock index.
R square – 0.304 The R square measures the strength of the relationship, how strong or weak the relationship is. In this case we can conclude that the variability of the stock market index explains only 30.4% of the stock returns.
Sun Microsystems
P-Value – 0.635 It indicates that the significant relationship between the returns of the market and the performance of the markets index is very low.
Coefficient – 2.219 The slope is of the graph is positive which indicates that the stock returns increases relatively to the increase in the stock index.
R square – 0.441 The R square measures the strength of the relationship, how strong or weak the relationship is. In this case we can conclude that the variability of the stock market index explains only 44.1% of the stock returns. (Draper & Smith, 1998)
Silicon
P-Value – 0.697 It indicates that the significant relationship between the returns of the market and the performance of the markets index is very low.
Coefficient – 2.338 The slope is of the graph is positive which indicates that the stock returns increases relatively to the increase in the stock index.
R square – 0.067 The R square measures the strength of the relationship, how strong or weak the relationship is. In this case we can conclude that the variability of the stock market index explains only 6.7% of the stock returns.
The Relationship Between RET and WRETD
My findings that are based on the graph above indicate that there is no relationship between the returns on the stock market and the general performance of the stock index. My predictions were that the relationship that exists between the stock market and the performance of the individual stocks is very limited.
Macro-Economic Analysis
USA Macro-Economic Indicators
Source: http://research.stlouisfed.org/fred2/tags/series?t=&pageID=9
Source: http://research.stlouisfed.org/publications/iet/
Source : http://research.stlouisfed.org/publications/iet/
The analysis from the above graphs indicate that there is a significant relationship between the returns on company stocks and the macro economic factors such as real GDP growth, unemployment level and inflation rate. When the macro-economic factors in the growing are positively improving then most company stocks post good returns. When the factors are negative, for instance when the rates of inflation and unemployment are so high then the stock returns also post low returns. In the year 2008, during the global economic crisis, most economies registered negative real GDP growth, the unemployment levels were so high and inflation rates were at their peak in most countries. The stock returns for most countries were also affected negatively and they registered a drop in their earnings. When inflation rates are so high most companies lay off workers to reduce expenses and decrease borrowings due to the high cost of borrowing while unemployment levels increases, the real GDP growth also decreases due to reduced circulation of money in the economy. (Swann, 2009) The company stocks are calculated and classified as per its volatility and in accordance with the stock market risks and beta. During the economic crisis of 2008, the volatility of most stocks were at their highest together with the term of most bonds.
- My investment strategy would be to invest as per the performance of the individual company stock and not the general performance of the stock market.
References
Cairns, J (2004). Interest Rate Models – An Introduction. Princeton University Press.
Chen, N., Roll, R. and Ross, S.A. (1986) Economic Forces and the Stock Market. Journal of Business.
Draper, N.R., Smith, H. (1998). Applied Regression Analysis (3rd Ed.). John Wiley.
Sullivan, Sheffrin, S (2003). Economics: Principles in action. Upper Saddle River, New Jersey
Pearson, Prentice Hall.
Swann, C. (2009) “GDP and the Economy – Advance Estimates for the Second Quarter of 2009,” Survey of Current Business, August 2009.
http://research.stlouisfed.org/fred2/tags/series?t=&pageID=9
http://research.stlouisfed.org/publications/iet
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