The Predictive Content of Financial Variables: Evidence from the Euro Area

Abstract

This paper investigates the predictive ability of financial variables for real growth in the euro area through bivariate and multivariate non-parametric Granger causality tests. Apart from assessing the within-country forecasting ability of commonly-employed financial variables, such as the term spread, the stock market returns and the growth of real money supply, we also test for cross-country influences. Employing a monthly dataset for the period from January 1988 to May 2005, we find that financial variables are useful leading indicators for euro area growth at a joint level, albeit at different horizons, ranging from one to six quarters. In addition to non-parametrically testing for Granger causality, we consider testing the out of sample forecasting ability of the respective financial variables in a parametric framework for the period from 2001 onwards. Our results from this parametric framework corroborate our non-parametric findings, yielding the stock market returns and the term spread as the single more powerful predictor on a country and euro area basis, respectively.

Keywords: Granger causality, forecasting accuracy, money supply, output growth, term spread, stock returns

JEL Classification: E52, C14