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Leading indicator information in UK equity prices: an assessment of economic tracking portfolios

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  • Simon Hayes
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    Abstract

    An economic tracking portfolio (ETP) is a portfolio of financial assets whose returns are correlated with some macroeconomic variable of interest. Specifically, an ETP is designed to track revisions to investors' expectations about the target macroeconomic variable. This paper evaluates whether ETPs provide information about expectations of future macroeconomic outcomes, and are thus a useful tool for conjunctural economic assessment. A set of ETPs is estimated using UK equity returns for three target variables: inflation, industrial production growth, and growth in the volume of retail sales. In sample, it is possible to track all three of the target variables with equity returns. But the out-of-sample results are poor. Although some ETPs retain significant explanatory power, most do not, and in all cases there is a substantial deterioration in the relationship between the ETPs and the target variables. Covariances between equity returns and macroeconomic variables appear to change substantially over time, and the consequent instability in portfolio weights significantly diminishes the usefulness of ETPs for conjunctural analysis.

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    Bibliographic Info

    Paper provided by Bank of England in its series Bank of England working papers with number 137.

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    Date of creation: May 2001
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    Handle: RePEc:boe:boeewp:137

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    1. Campbell, John, 1991. "A Variance Decomposition for Stock Returns," Scholarly Articles 3207695, Harvard University Department of Economics.
    2. Artis, M J, et al, 1995. "Predicting Turning Points in the UK Inflation Cycle," Economic Journal, Royal Economic Society, vol. 105(432), pages 1145-64, September.
    3. Campbell, John, 1987. "Stock Returns and the Term Structure," Scholarly Articles 3207699, Harvard University Department of Economics.
    4. Francis X. Diebold & Glenn D. Rudebusch, 1987. "Scoring the leading indicators," Special Studies Papers 206, Board of Governors of the Federal Reserve System (U.S.).
    5. Clare, A D & Thomas, S H & Wickens, M R, 1994. "Is the Gilt-Equity Yield Ratio Useful for Predicting UK Stock Returns?," Economic Journal, Royal Economic Society, vol. 104(423), pages 303-15, March.
    6. Canova, Fabio & De Nicolo', Gianni, 1995. "Stock returns and real activity: A structural approach," European Economic Review, Elsevier, vol. 39(5), pages 981-1015, May.
    7. Breeden, Douglas T & Gibbons, Michael R & Litzenberger, Robert H, 1989. " Empirical Tests of the Consumption-Oriented CAPM," Journal of Finance, American Finance Association, vol. 44(2), pages 231-62, June.
    8. Artis, Michael J, et al, 1995. "Turning Point Prediction for the UK Using CSO Leading Indicators," Oxford Economic Papers, Oxford University Press, vol. 47(3), pages 397-417, July.
    9. Andreou, Elena & Osborn, Denise R & Sensier, Marianne, 2000. "A Comparison of the Statistical Properties of Financial Variables in the USA, UK and Germany over the Business Cycle," Manchester School, University of Manchester, vol. 68(4), pages 396-418, Special I.
    10. Barro, Robert J, 1990. "The Stock Market and Investment," Review of Financial Studies, Society for Financial Studies, vol. 3(1), pages 115-31.
    11. Arthur F. Burns & Wesley C. Mitchell, 1946. "Measuring Business Cycles," NBER Books, National Bureau of Economic Research, Inc, number burn46-1, June.
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    Cited by:
    1. Junttila, Juha, 2007. "Forecasting the macroeconomy with contemporaneous financial market information: Europe and the United States," Review of Financial Economics, Elsevier, vol. 16(2), pages 149-175.
    2. Junttila, Juha & Kinnunen, Heli, 2004. "The performance of economic tracking portfolios in an IT-intensive stock market," The Quarterly Review of Economics and Finance, Elsevier, vol. 44(4), pages 601-623, September.

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