Does Money Supply Growth Contain Predictive Power for Stock Returns? Evidence and Explanation
48 Pages Posted: 10 Sep 2014 Last revised: 5 Jun 2015
Date Written: June 5, 2015
We examine the nature of predictive power of money supply growth for stock returns. An understanding of which would be useful for market practitioners and policy makers given the current lack of consensus. In addition, knowledge of this relationship can aid our understanding of the risk and cash flow channels of stock price movement. Using monthly data and considering a range of alternative predictor variables, predictive and forecast time horizons, empirical methodologies and measures of stock returns, we find that money supply growth has a negative predictive relation with stock returns. Rolling window forecasts provide confirmatory out-of-sample evidence for the significance of money supply growth as a predictor variable. The use of both returns and dividend growth predictive regressions, as well as a VAR analysis and predictive regressions for size and book-to-market portfolios suggest that relationship operates through a risk channel. Higher money supply leads to improving economic conditions and lower (required) returns.
Keywords: Stock Returns, Money Supply, Predictability, Asset Price Movement, Forecasting
JEL Classification: C22, G12
Suggested Citation: Suggested Citation