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

Abstract

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

McMillan, David G., Does Money Supply Growth Contain Predictive Power for Stock Returns? Evidence and Explanation (June 5, 2015). Available at SSRN: https://ssrn.com/abstract=2493730 or http://dx.doi.org/10.2139/ssrn.2493730

David G. McMillan (Contact Author)

University of Stirling ( email )

Stirling, Scotland FK9 4LA
United Kingdom

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