Going granular: The importance of firm-level equity information in anticipating economic activity

The paper attempts to verify whether equity returns of individual firms, and their realized volatilities, improve the in-sample and out-of-sample predictability of the US business cycle, as measured by the IP index VAR analysis and tests for forecasting ability The equity returns of individual firms, and their realized volatilities, are shown to improve the in-sample and out-of-sample predictability of the US business cycle, as measured by the IP index. In fact, significant declines in the root mean squared errors (RMSEs) are found when these variables are added to aggregate financial variables and selected macroeconomic indicators. Overall, to the aim of forecasting, there is a noticeable swing in the relative importance of individual firms across time, although firms that become key predictors of economic activity in a given month continue to do so for around six months, on average, bringing support to the idea that there is structure in the information that they convey. Unconditionally, belonging to a given sector does not boost the predictive power of firms, but we find that it becomes important for example around periods of recessions. Balance sheet data show that predictive ability of the firms is associated with features as performance, liquidity, the size of the foreign activity. Firm size also matters, as suggested by recent literature (Gabaix, 2011), although it is not - as put forward there - the only indicator to prevail.