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What's good for GM...? Using auto industry stock returns to forecast business cycles and test the Q-theory of investment

  • Gregory R. Duffee
  • Steven D. Prowse

We examine the ability of auto industry stock returns to forecast quarterly changes in the growth rates of real GDP, consumption, and investment. We find that auto stock returns are superior to aggregate stock market returns in predicting growth rates of GDP and various forms of consumption. The superior predictive power of auto returns holds for both in-sample and out-of-sample forecasts and has not declined over time. We then apply a finding in this paper---that market returns have no explanatory power for future output or consumption growth when auto returns are included in the regression---to analyze the causal relation between the stock market and investment. We use auto returns to proxy for forecasts of future fundamentals, allowing market returns to capture the effect of the stock market on investment. We find that aggregate returns forecast equipment investment in the presence of auto returns, providing empirical support for q-theory. Results for structures investment are less convincing.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 96-38.

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Date of creation: 1996
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Handle: RePEc:fip:fedgfe:96-38
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  1. Olivier Blanchard & Changyong Rhee & Lawrence Summers, 1990. "The Stock Market, Profit and Investment," NBER Working Papers 3370, National Bureau of Economic Research, Inc.
  2. Galeotti, Marzio & Schiantarelli, Fabio, 1994. "Stock Market Volatility and Investment: Do Only Fundamentals Matter?," Economica, London School of Economics and Political Science, vol. 61(242), pages 147-65, May.
  3. Robert J. Barro, 1989. "The Stock Market and Investment," NBER Working Papers 2925, National Bureau of Economic Research, Inc.
  4. Hall, Robert E, 1978. "Stochastic Implications of the Life Cycle-Permanent Income Hypothesis: Theory and Evidence," Journal of Political Economy, University of Chicago Press, vol. 86(6), pages 971-87, December.
  5. James H. Stock & Mark W. Watson, 1993. "A Procedure for Predicting Recessions with Leading Indicators: Econometric Issues and Recent Experience," NBER Chapters, in: Business Cycles, Indicators and Forecasting, pages 95-156 National Bureau of Economic Research, Inc.
  6. Arturo Estrella & Frederic S. Mishkin, 1996. "Predicting U.S. recessions: financial variables as leading indicators," Research Paper 9609, Federal Reserve Bank of New York.
  7. Mankiw, N. Gregory, 1982. "Hall's consumption hypothesis and durable goods," Journal of Monetary Economics, Elsevier, vol. 10(3), pages 417-425.
  8. Randall Morck & Andrei Shleifer & Robert W. Vishny, 1990. "The Stock Market and Investment: Is the Market a Sideshow?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 21(2), pages 157-216.
  9. Fischer, Stanley & Merton, Robert C., 1984. "Macroeconomics and finance: The role of the stock market," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 21(1), pages 57-108, January.
  10. Barry Bosworth, 1975. "The Stock Market and the Economy," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 6(2), pages 527-300.
  11. Tobin, James, 1969. "A General Equilibrium Approach to Monetary Theory," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 1(1), pages 15-29, February.
  12. Long, John B, Jr & Plosser, Charles I, 1983. "Real Business Cycles," Journal of Political Economy, University of Chicago Press, vol. 91(1), pages 39-69, February.
  13. Kydland, Finn E & Prescott, Edward C, 1982. "Time to Build and Aggregate Fluctuations," Econometrica, Econometric Society, vol. 50(6), pages 1345-70, November.
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