Are Macroeconomic Factors Adequate Proxies for Systematic Influences in Stock Returns?

37 Pages Posted: 9 May 2019

See all articles by Jan Szczygielski

Jan Szczygielski

Department of Financial Management, University of Pretoria; Department of Accounting and Financial Management,Newcastle Business School, Northumbria University

Leon Brummer

affiliation not provided to SSRN

Hendrik Wolmarans

affiliation not provided to SSRN

Date Written: April 10, 2019

Abstract

This paper investigates whether pre-specified macroeconomic factors can adequately proxy for the pervasive influences in stock returns, within the context of macroeconomic linear factor models motivated by the multifactor Arbitrage Pricing Theory (APT). Variation in stock returns can be attributed to systematic and idiosyncratic sources of variation. As idiosyncratic factors can be diversified away, systematic variation will remain and the only factors that will be relevant will be those representative of systematic influences. In this study, systematic influences are quantified by statistically derived factor scores which are then related to a set of carefully selected macroeconomic factors. The identification of macroeconomic factors that proxy for systematic influences in returns is a challenge in itself. Once identified, macroeconomic factors are found to be poor and unstable proxies for systematic influences. The use of a residual market factor, an often-applied solution the factor omission problem in linear factor models motivated by the APT, does not significantly improve the approximation of factor scores. Macroeconomic factors are unlikely to provide a complete representation of the return generating process. Researchers should recognize that macroeconomic linear factor models are likely to be underspecified, even if a residual market factor is included.

Keywords: Macroeconomic Factors, Factor Scores, Linear Factor Model, Systematic Influences, Arbitrage Pricing Theory

JEL Classification: C01, C22, C58, G12

Suggested Citation

Szczygielski, Jan and Szczygielski, Jan and Brummer, Lean and Wolmarans, Hendrik, Are Macroeconomic Factors Adequate Proxies for Systematic Influences in Stock Returns? (April 10, 2019). Available at SSRN: https://ssrn.com/abstract=3369798 or http://dx.doi.org/10.2139/ssrn.3369798

Jan Szczygielski (Contact Author)

Department of Financial Management, University of Pretoria ( email )

Physical Address Economic and Management Sciences
Pretoria, Gauteng 0002
South Africa

Department of Accounting and Financial Management,Newcastle Business School, Northumbria University

Newcastle Upon Tyne
Newcastle Upon Tyne, NE1 8ST
United Kingdom

Lean Brummer

affiliation not provided to SSRN

Hendrik Wolmarans

affiliation not provided to SSRN

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