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Nonlinearity and Endogeneity in Macro-Asset Pricing

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Author Info
Craig Hiemstra (University of Strathclyde)
Charles Kramer (International Monetary Fund)
Abstract

Linear asset-pricing relations, with macroeconomic factors as state variables, have found wide usein empirical finance. Applications of such relations range from academic studies of market efficiency andmarket anomalies to practical uses such as risk management and estimation of the cost of capital. Theseapplications make two key assumptions: that the relationship is exclusively linear, and that the macroeconomicfactors are exogenous to returns. For the set of macrofactors commonly used in these applications, bothassumptions run counter to economic intuition. We set out to demonstrate that they are also counter toempirical evidence.We carry out this task using tests for linear and nonlinear Granger causality. We find linear and nonlinearfeedback between stock returns and commonly used macroeconomic pricing factors. We also find linear andnonlinear feedback between residuals from linear pricing relations and returns. In addition, there is littleevidence to suggest that neglected autoregressive or autoregressive conditionally heteroskedastic dynamics areresponsible for these findings, implying that the underlying dynamics are complicated. Thus, linearasset-pricing relations omit interesting and potentially useful aspects of the relationship between stock returnsand the macroeconomy.

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Publisher Info
Article provided by Berkeley Electronic Press in its journal Studies in Nonlinear Dynamics & Econometrics.

Volume (Year): 2 (1997)
Issue (Month): 3 ()
Pages: 61-76
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Handle: RePEc:bep:sndecm:2:1997:3:61-76

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Related research
Keywords: Granger causality financial markets arbitrage pricing theory

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Chen, Nai-Fu, 1991. " Financial Investment Opportunities and the Macroeconomy," Journal of Finance, American Finance Association, vol. 46(2), pages 529-54, June. [Downloadable!] (restricted)
  2. William A. Brock, 1993. "Pathways to randomness in the economy: Emergent nonlinearity and chaos in economics and finance," Estudios Económicos, El Colegio de México, Centro de Estudios Económicos, vol. 8(1), pages 3-55.
    Other versions:
  3. Breeden, Douglas T., 1979. "An intertemporal asset pricing model with stochastic consumption and investment opportunities," Journal of Financial Economics, Elsevier, vol. 7(3), pages 265-296, September. [Downloadable!] (restricted)
  4. Bansal, Ravi & Viswanathan, S, 1993. " No Arbitrage and Arbitrage Pricing: A New Approach," Journal of Finance, American Finance Association, vol. 48(4), pages 1231-62, September. [Downloadable!] (restricted)
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  6. Merton, Robert C, 1973. "An Intertemporal Capital Asset Pricing Model," Econometrica, Econometric Society, vol. 41(5), pages 867-87, September. [Downloadable!] (restricted)
  7. Ng, Victor & Engle, Robert F. & Rothschild, Michael, 1992. "A multi-dynamic-factor model for stock returns," Journal of Econometrics, Elsevier, vol. 52(1-2), pages 245-266. [Downloadable!] (restricted)
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  1. Cetin Ciner, 2001. "Energy Shocks and Financial Markets: Nonlinear Linkages," Studies in Nonlinear Dynamics & Econometrics, Berkeley Electronic Press, vol. 5(3), pages 1079-1079. [Downloadable!] (restricted)
  2. Aitor Ciarreta Antuñano & Ainhoa Zarraga Alonso, 2007. "Electricity consumption and economic growth: evidence from Spain," BILTOKI 200701, Universidad del País Vasco - Departamento de Economía Aplicada III (Econometría y Estadística). [Downloadable!]
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