The information content of US stock market factors

What is it about?

This paper considers the degree of 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. Given, the large number of stock market factors suggested in the literature, it is important to consider the information content of each factor and whether it adds to our understanding of markets and the economy. 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, using US data, support the view 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 do they provide any predictive power for future output growth. Thus, they appear to contain very little economic content. However, the results do suggest that the impact of these factors as measures of stock market risk is more prominent with higher macroeconomic risk (contractionary regime). Overall, the results indicate that 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.

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Photo by Adeolu Eletu on Unsplash

Photo by Adeolu Eletu on Unsplash