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Permanent and transitory components of GDP and stock prices: further analysis

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  • Jesus Gonzalo
  • Tae-Hwy Lee
  • Weiping Yang

Abstract

Using the conventional VAR identification approach, Cochrane (Quarterly Journal of Economics 107: 241-65, 1994) finds that substantial amounts of variation in GDP growth and stock returns are due to transitory shocks. Following the common trend decomposition of King etal. (American Economic Review 81: 819-40, 1991), we show that Cochrane's results depend on the assumption of weak exogeneity of one of the variables with respect to the cointegration vector. When this assumption holds both approaches coincide. If not, the shocks Cochrane called transitory are not totally transitory. In this case, the conventional VAR approach with the assumption of the weak exogeneity may overstate the magnitude of transitory shocks and understate that of permanent shocks. We find that the permanent components of GDP and stock prices are much larger than those estimates of Cochrane, although substantial (but much smaller than in Cochrane 1994) variations in GDP growth and stock returns are attributed to transitory shocks.

Suggested Citation

  • Jesus Gonzalo & Tae-Hwy Lee & Weiping Yang, 2008. "Permanent and transitory components of GDP and stock prices: further analysis," Macroeconomics and Finance in Emerging Market Economies, Taylor & Francis Journals, vol. 1(1), pages 105-120.
    • Handle: RePEc:taf:macfem:v:1:y:2008:i:1:p:105-120
    DOI: 10.1080/17520840701864955
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    Cited by:

    1. Nazliben, K. Korhan & Rodríguez, Juan Carlos, 2018. "Permanent shocks, signal extraction, and portfolio selection," Journal of Economic Dynamics and Control, Elsevier, vol. 92(C), pages 47-68.
    2. Clegg, Matthew & Krauss, Christopher & Rende, Jonas, 2017. "partialCI: An R package for the analysis of partially cointegrated time series," FAU Discussion Papers in Economics 05/2017, Friedrich-Alexander University Erlangen-Nuremberg, Institute for Economics.

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    Keywords

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    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)

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