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Can stock market liquidity and volatility predict business cycles?

Author

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  • Benjamin Carlston

Abstract

Purpose - The purpose of this paper is to predict real gross domestic product (GDP) growth and business cycles by using information from both liquidity and volatility measures. Design/methodology/approach - The paper estimates liquidity and volatility measures from over 5,000 NYSE rms and extracts a common factor, which the paper calls uncertainty. In-sample and out-of-sample forecasting tests are used to determine the ability of the uncertainty factor to predict growth in real GDP, industrial production, consumer price index, real consumption and changes in real investment. Findings - The paper finds that on average, positive shocks to the uncertainty factor occur in the quarters preceding and at the beginning of a recession. During the quarters toward the end of recessions, there are negative shocks to uncertainty on average. Originality/value - Previous research has explored using either liquidity or volatility to forecast economic activity. The paper bridges the two branches of research and finds a link to real GDP growth and business cycles.

Suggested Citation

  • Benjamin Carlston, 2018. "Can stock market liquidity and volatility predict business cycles?," Studies in Economics and Finance, Emerald Group Publishing Limited, vol. 35(1), pages 81-96, March.
    • Handle: RePEc:eme:sefpps:sef-05-2016-0131
    DOI: 10.1108/SEF-05-2016-0131
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    Cited by:

    1. Xiao-Lin Li & Yi-Na Li & Lu Bai, 2019. "Stock Market Cycle and Business Cycle in China: Evidence from a Bootstrap Rolling Window Approach," Review of Economics & Finance, Better Advances Press, Canada, vol. 17, pages 35-50, August.

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