The news in financial asset returns

The notion that financial asset returns are predictors of future economic activity is widespread, but detailed analyses provide little support for financial markets' ability to reveal future economic activity. Even though the evidence on various indicators used by different researchers is mixed, the authors of this article explore the notion that financial markets reveal useful information about future economic activity. This article examines and answers two questions: First, what is a good way of extracting information about future economic activity from asset prices? Second, do financial asset returns help predict economic activity over horizons from one month to five years? To determine whether news of an asset's excess return can reveal information about unexpected economic activity, the authors construct a method of extracting the news about future economic activity from returns on financial assets. The authors use linear regressions to relate the unexpected parts of economic activity and the asset's return to actual economic activity and the actual return on an asset. The evidence in the article shows that movements in financial markets do presage developments in the economy. The authors find that movements in the overall stock market and bond returns are the most important financial indicators. It remains to be seen whether those indicators hold up to variations in technique or the passage of time
Are returns on financial markets useful for predicting the future course of the economy? It is widely thought that financial markets' movements reflect the economy's future and that finding the [...]