Time-Varying Stock Return Correlation, News Shocks, and Business Cycles

50 Pages Posted: 17 Mar 2023

See all articles by Norbert Metiu

Norbert Metiu

Deutsche Bundesbank

Esteban Prieto

Deutsche Bundesbank - Economic Research Centre

Date Written: 2023

Abstract

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

Metiu, Norbert and Prieto, Esteban, Time-Varying Stock Return Correlation, News Shocks, and Business Cycles (2023). Deutsche Bundesbank Discussion Paper No. 05/2023, Available at SSRN: https://ssrn.com/abstract=4391261 or http://dx.doi.org/10.2139/ssrn.4391261

Norbert Metiu (Contact Author)

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany

Esteban Prieto

Deutsche Bundesbank - Economic Research Centre ( email )

Wilhelm-Epstein-Strasse 14
Frankfurt/Main D-60431
Germany

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