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Fiscal policy and the US stock market

Author

Listed:
  • Cedric L. Mbanga

    (Louisiana Tech University)

  • Ali F. Darrat

    (Louisiana Tech University)

Abstract

This paper empirically explores the short- and long-run effects of fiscal and monetary policies on US stock returns and tests the validity of market efficiency. The results support the presence of a strong long-run (equilibrium) relation binding stock prices with fiscal (but not monetary) policy. Further tests assign a dominant role to fiscal policy as a main force driving the overall equilibrium relation with the stock market. Estimates from error-correction models corroborate the existence of robust long-run relation and further suggest that past fiscal (but not monetary) policy actions exert significant short-run effects on current stock returns. A similar verdict emerged from alternative estimates in which fiscal policy actions anticipated from an ex ante equation continue to support a significant lagged relation with current stock returns. These results provide consistent evidence that important effects of fiscal policy are transmitted to the real economy through the stock market. Moreover, the results for fiscal policy appear at variance with market efficiency. However, transaction costs and other well-known modeling caveats may impede implications for profitable investment strategies.

Suggested Citation

  • Cedric L. Mbanga & Ali F. Darrat, 2016. "Fiscal policy and the US stock market," Review of Quantitative Finance and Accounting, Springer, vol. 47(4), pages 987-1002, November.
    • Handle: RePEc:kap:rqfnac:v:47:y:2016:i:4:d:10.1007_s11156-015-0528-y
    DOI: 10.1007/s11156-015-0528-y
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    6. Shahida Perveen, Mustaghis-ur-Rahman, 2018. "Impact of Fiscal and Monetary Policies on Stock Market Performance: An Empirical Study of Pakistan Stock Exchange," Journal of Finance and Economics Research, Geist Science, Iqra University, Faculty of Business Administration, vol. 3(2), pages 2-23, October.
    7. Cedric Mbanga & Ali F. Darrat & Jung Chul Park, 2019. "Investor sentiment and aggregate stock returns: the role of investor attention," Review of Quantitative Finance and Accounting, Springer, vol. 53(2), pages 397-428, August.
    8. Polyzos, Efstathios, 2022. "Examining the asymmetric impact of macroeconomic policy in the UAE: Evidence from quartile impulse responses and machine learning," The Journal of Economic Asymmetries, Elsevier, vol. 26(C).

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    More about this item

    Keywords

    Market efficiency; Fiscal and monetary policies; Cointegration; Error corrections;
    All these keywords.

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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