Time-Varying Stock Return Correlation, News Shocks, and Business Cycles
50 Pages Posted: 17 Mar 2023
Date Written: 2023
The cross-sectional average of pairwise correlations across stocks traded on the NYSE, AMEX, and Nasdaq is a powerful predictor of U.S. economic activity at a horizon of one to four years. Its predictive ability is on a par with the slope of the yield curve and significantly exceeds that of some other widely used financial indicators. The macroeconomic effects of an innovation to stock return correlation in a vector autoregression are nearly identical to those of a news shock about future productivity. Thus, market-wide changes in return correlation contain information about changes in future technological developments.
Keywords: Business Cycles, News Shock, Stock Market, Uncertainty
JEL Classification: E32, E44
Suggested Citation: Suggested Citation