Equity Returns, Unemployment, and Monetary Policy

32 Pages Posted: 23 Nov 2020 Last revised: 9 Dec 2020

See all articles by Yijie Li

Yijie Li

Aalto University - Department of Finance

Matti Suominen

Aalto University School of Business

Date Written: November 19, 2020

Abstract

We investigate both theoretically and empirically how unemployment level and its growth affect future stock returns. We find that both a higher unemployment rate and higher growth of unemployment positively predict future stock market returns. In our model, the effects come through their negative effect on equity market participation. Importantly, the two effects reinforce each other making stock returns exceptionally high in periods of high unemployment and high unemployment growth. Our findings are robust to alternative specifications, including using lagged unemployment data or unemployment forecasts. We document and examine theoretically why the same measures related to unemployment predict also the FED’s monetary policy. Controlling for FED’s future policies does not take away the return predictability.

Keywords: Equity returns, unemployment, unemployment growth, monetary policy, FED

JEL Classification: G10, G12, E52, E58, E24, E32

Suggested Citation

Li, Yijie and Suominen, Matti, Equity Returns, Unemployment, and Monetary Policy (November 19, 2020). Available at SSRN: https://ssrn.com/abstract=3724418 or http://dx.doi.org/10.2139/ssrn.3724418

Yijie Li

Aalto University - Department of Finance ( email )

Finland

Matti Suominen (Contact Author)

Aalto University School of Business ( email )

PO Box 1210
FI-00101 Helsinki
Finland
+358-50-5245678 (Phone)

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