Credit Conditions and Expected Stock Returns

Abstract:     
We analyze the predictability of U.S. stock returns using a measure of credit standards (Standards) derived from the Federal Reserve Board's Senior Loan Officer Opinion Survey on Bank Lending Practices. We find that Standards is a strong predictor of stock returns at a business cycle frequency, especially in the post-1990 data period. Empirically we find that a tightening of Standards predicts lower future stock returns. Standards performs well both in-sample and out-of-sample and is robust to a host of consistency checks including a small sample analysis. Further, alleviating data snooping concerns, we find that the Canadian equivalent of Standards predicts Canadian stock market returns. Finally, we explore the source of predictability of Standards and show that Standards provides information about cash flow news.

Number of Pages in PDF File: 46

Keywords: Stock predictability, macroeconomics and financial markets, survey data

JEL Classification: E44, G12, G14, G17, G21

working papers series