Output growth, inflation and interest rate on stock return and volatility: the predictive power

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1 Oupu growh, nflaon and neres rae on soc reurn and volaly: he predcve power Wa Chng POON* and Gee Ko TONG** * School of Busness, Monash Unversy Sunway Campus, Jalan Lagoon Selaan, Bandar Sunway, Selangor, Malaysa. Tel: +6(0) E-mal: poon.wa.chng@buseco.monash.edu.my ** School of Informaon Technology, Mulmeda Unversy, Persaran Mulmeda, 6100 Cyberjaya, Selangor, Malaysa. Tel: +6(0) E-mal: gong@mmu.edu.my Absrac Usng monhly daa from seven maure and emergng mares and GARCH and EGARCH models, he sudy of Davs and Kuan (Appled Fnancal Economcs, 1, , 00) on nflaon and oupu on soc reurns and volaly s exended by ncludng neres rae o compare he effec beween hree maure mares (US, Japan and Sngapore) and four crss experenced emergng mares (Malaysa, Inda, Korea and Phlppnes). Resuls reveal ha economc volaly, as measured by movemen n nflaon, oupu growh, and neres rae, has wea predcor power on soc mare volaly and reurns. In lne wh he evdence repored n Davs and Kuan (00), he fndngs sugges ha he Fsher effec n soc reurns among he seven maure and emergng mares s no suppored. Keywords: predcve power, oupu, nflaon, neres rae, soc reurn volaly 1. Inroducon In conjuncon wh fnancal crss and he subsanal varably n producon levels, a queson on he relaonshp beween soc reurns and economc acvy arses (Mauro, 000). Sudy on he mpac of nflaon, oupu growh and neres rae movemen on condonal soc mare volaly has mporan mplcaons for nvesors and polcy maers. Hgh mare volaly ncreases unfavourable mare rs premum. I s crcal for polcy maers o reduce he soc mare volaly and ulmaely enhance economy sably n order o mprove he effecveness of he asse allocaon decsons. Whle prevous sudes have examned he relaonshp beween macroeconomc facors and soc reurn volaly, no sudy s placed on real oupu, nflaon and neres rae n sync as exogenous varables n boh he mean and condonal varance equaons o smulaneously esmae he effec of hese varables on soc mare reurns. Ths paper s he exenson of Davs and Kuan s (00) sudy who employed Generalzed Auo- Regressve Condonal Heeroscedascy (GARCH) and Exponenal GARCH (EGARCH) models o smulaneously esmae he predcve power of real oupu and 1

2 nflaon on monhly soc reurns and volaly usng daa from 1 counres. The man purpose of hs paper s o esmae he predcve power of oupu growh, nflaon and neres rae on monhly soc reurn and her condonal volaly usng he daa from hree maure mares (hereafer MM) and four Asa emergng mares (hereafer EM) for nomnal soc reurns predcon. Ths paper employed GARCH and EGARCH models as proposed by Bollerslev (1986) and Nelson (1991) respecvely snce hese models accoun for condonal volaly. Furhermore, EGARCH model s suable for asymmerc volaly me seres daa, consderng me varyng volaly (volaly cluserng) on soc reurn. The resul can also be used o explan he volaly of soc mare reurn and examne he valdy of Fsher Effecs n nernaonal soc reurns. Ths paper s organzed as follows. Secon provdes a revew of he relevan leraure. Secon oulnes he mehodology, presens daa used and sample perod. Secon 4 dscusses he emprcal resuls and he mplcaons of he fndngs, and secon 5 concludes he paper.. Leraure Revew Sudes on soc mare volaly have been repored n he exan leraure. The varably of he mare facor of he New Yor Soc Exchange s lned o he volaly of macroeconomc varables (Offcer, 197). Mxed evdence beween soc reurns and oupu economc acvy were exhbed from he pas sudes. McQueen and Roley (199) clamed ha a posve relaon beween fuure economc acvy and soc reurns. The posve lnage beween he wo can be hrough a channel mechansm where hgher soc reurns have a b-dreconal effec on hgher consumpon and nvesmen levels ha ulmaely enhance economc acvy. On he oher hand, he emprcal evdence ndcaed negave lnage beween soc reurns and pas economc acvy for he US (Balvers e al., 1990). Also, Tsouma (008) explaned he exsence of a negave lnage beween curren economc acvy and fuure soc reurns. However, does no always show a negave sgnfcan relaonshp n he G-7 counres (Hassaps and Kalyvs, 00). Smlarly, Lee (199) found ha economc acvy does no sgnfcanly explan he varably n he soc reurns n he US economy. In addon, Bnswanger (000) found no predcor varaon n fuure reurns correlaed wh economc acvy for he US durng he perod Meanwhle, Campbell and Henschel (199), Braun e al. (1995), and Beaer and Harvey (1997) found ha here were me-varyng volales n soc reurn. Aggarwal e al. (1999) who suded volaly n emergng soc mares found ha durng he Mexcan peso crss, he Flpnos Marcos-Aquno conflc, and he Indan soc mare scandal, sgnfcan volales n he soc mare oo place wh hgher volaly durng recesson (Schwer, 1989). Therefore, s hypoheszed ha hgher predcve power of oupu growh and nflaon on monhly soc reurn and volaly n he fnancal crss counry, a pror. Schwer (1989a) suded he relaon of soc volaly wh economc acvy, fnancal leverage and soc radng acvy usng he US monhly daa from 1857 o Resuls revealed ha aggregae leverage s sgnfcanly correlaed wh volaly and explans

3 relavely small movemens n soc volaly. Usng smple models of soc valuaon, he characerzed he changes n soc mare volaly o me-varyng volaly was unusually hgh durng Grea Depresson, and found wea evdence of nflaon, ndusral producon growh raes, and moneary base growh raes n predcng soc mare volaly. Schwer beleved ha he condonal varance of soc prces s proporonal o he condonal varance of he expeced fuure cash flows f dscoun raes are consan over me. In addon o ha, Schwer (1989b) clamed ha soc volaly ncreases for mmedae effec followng he wors pancs, bu here s absen of long-erm effecs on volaly. Macroeconomc volaly s relaed o long- and shor-erm neres rae (Mascaro and Melzer, 198). Soc reurn volaly s correlaed wh neres rae (Schwer, 1989a). Many sudes nvesgae he nerdependency beween soc reurns and neres rae, ye he evdence s mxed. Prevous sudes found negave correlaon beween changes n neres rae and soc reurns, among hose, are Fama and Schwer (1977), and Gese and Roll (198). Pero (1996) furher argued ha soc reurns are affeced by curren changes n he neres rae and by fuure changes n producon. The changes n neres rae seem o be hgher han changes n producon. Doman, Glser, and Louon (1996) argued ha falls n neres rae are followed by welve monhs of excess soc reurns whle ncreases n neres raes have lle effecs. However, Tman and Warga (1989) found posve relaon beween soc reurn and fuure neres rae changes. Fsher (190) assered ha he nomnal neres rae consss of a real rae plus he expeced nflaon rae. Fsher Hypohess saed ha expeced real rae of he economy s deermned by he real facors such as producvy of capal and me preference of savers and s ndependen of he expeced nflaon rae. If Fsher effec holds, here s no change n nflaon and nomnal soc reurns snce soc reurns are allowed o hedge for nflaon. Some opposed o Fsher Hypohess, and clamed ha he real raes of common soc reurn and expeced nflaon raes are ndependen and ha nomnal soc reurns vary n one-o-one correspondence wh expeced nflaon. On he oher hand, usng Pgou real wealh effec, Mundell (196) revealed ha he real rae of neres s negavely relaed o expeced nflaon. Sanomero (197) shows ha changes n he growh rae of he labour producvy may gve rse o a drec relaon beween he expeced real rae and expeced nflaon. Furhermore, nroducng progressve ncome axes may cause furher dependences beween wo varables.. Mehodology Seven counres are seleced n hs sudy wh hree MM (Japan, USA, Sngapore) and four Asa crss experenced EM (Malaysa, Korea, Phlppnes, and Inda). The counry selecon crera are drven by daa avalably. Monhly daa on soc prces ndces, ndusral producon ndex and consumer prce Index (CPI), reasury blls rae, money mare rae for he sample perod are used n hs paper. Due o daa unavalably, daa for counres were sarng from dfferen perod, bu ended a he same perod as shown n Table. The daa for Japan and US were avalable from 1957 Augus onwards, whle mos of he EM were sared from early 1980s. All daa are obaned from Inernaonal

4 Fnancal Sascs (IFS) daabase. The manufacurng producon ndex was used as a proxy for ndusral producon ndex for Phlppnes. T-Blls Rae was used as proxy for changes n shor erm neres rae for US, Malaysa, and Sngapore, whle money mare raes were used for Japan, Korea, Phlppnes and Inda. Tae he logarhmc dfference of he soc ndces, CPI and ndusral producon ndces o generae soc reurn, nflaon and oupu growh respecvely. All varables are based n he log-dfferenced, mulpled by 100. Mos me seres daa become saonary afer frs dfferences. Bu hs ransformaon ofen exhbs volaly, whch suggess ha varance of fnancal me seres vares over me. In order o overcome hs problem, GARCH and EGARCH are used o accoun for varyng varance. GARCH as proposed by Bollerslev (1986) s employed o es f monhly soc reurns have me-varyng volaly, whle EGARCH model as proposed by Nelson (1991) s appled o verfy wheher shoc on soc reurns volaly s asymmery. I s followed by esmang he mpac of oupu growh, nflaon, and neres rae on soc mares reurns and her volales. Followng Bollerslev and Wooldrdge (199), robus varance esmaor s employed o compue asympoc sandard errors. A comparson sudy of volaly beween MM and EM are hen followed. Table 1 depcs he mporan evens ha caused sudden changes n volaly n seleced emergng mares. Table 1: Evens nfluencng volaly n seleced emergng mares Counres Perod Evens Inda o July o Rupee s es o Pound serlng were broen, and floang o a base of currences. Balance of paymens crss, unsable governmen due o elecons. IMF and World Ban approved emergency loans o repay nernaonal debs. Soc mare scandal. Conrols on capal and money mare nsrumens. Malaysa 1985 Banng crses due o economc recesson, bubble burs and wea demand. Ocober 1987 crash, Chnese-Malay ros. Increased reserved requremens, capal conrol measures. Capal conrol. Peg exchange rae o USD o o o o Phlppnes o o February 199 Souh Korea 1984 Augus o January 199 November 1997 December 1997 Begnnng of capal flgh. Marcos-Aquno conflc, coup aemp. Deb problems, coup aemp. The IMF approved an exenson of 18-monh sandby cred. The governmen lfed all foregn exchange resrcons allowng foregn nvesors o freely reparae her capal. Mnmum and maxmum ban neres rae ranges were nroduced. Large rade defc. Soc mare was opened o nvesors. The governmen abandoned s defence of won, sough loan from IMF. Korea go balou pacage from IMF. 4

5 Noe: * Adaped from Aggarwal e al. (001), Baaer and Harvey (004), auhors complaon. GARCH model s esmaed usng he maxmum lelhood, assumng ha he error erms are condonally normally dsrbued. Followng Davs and Kuan (00), he condonal varance s modelled by GARCH (1,1) specfcaon. GARCH (1,1) refers o he presence of a frs-order GARCH erm and a frs-order ARCH erm. In he sandard GARCH (1,1) specfcaon nroduced by Bollerslev (1986), he mean equaon n Eq.(1) s wren as a funcon of exogenous or predeermned endogenous varables, x, wh an error erm. The esmaed condonal varance,, s he one-perod ahead forecas varance based on s pas nformaon. The condonal varance equaon specfed n Eq.() s a funcon of consan varance ( ), news abou he volaly from he prevous perod, measured as he lag of he squared resdual from he mean equaon, (he ARCH erm), and he pas varance, 1 (he GARCH erm). Monhly seasonal dummes varables are also ncluded n hose models. ' 1 y ' (1) x 1 () 1 For GARCH (1,1) model, he conrbuon o he log lelhood from observaon s as follows: l log( ) log y x ' / () y x ' (4) where Ths model s conssen wh he volaly cluserng, where large changes n reurns are lely o be followed by furher large changes. For counres ha experence asymmerc soc reurn volaly due o he downward movemens n he mare would be followed by hgher volales han upward movemens n he same magnude. Ths phenomenon happens because good and bad news generae dfferen mpac on soc reurn volaly. EGARCH (1,1) as proposed by Nelson (1991) s employed o accoun for hs phenomenon. The specfcaon for he condonal varance used s shown n Eq. (5). log 1 1 log 1 (5) 1 1 The lef hand sde of Eq.(5) s he log of he condonal varance. Ths mples ha he leverage effec s exponenal, and hs wll guaranee ha he forecas of he condonal 5

6 varance wll no be negave. The presence of he leverage effecs can be esed by he hypohess where >0. The mpac s asymmerc f 0. I s noeworhy ha wo dfferences beween he Evews specfcaon of he EGARCH model and he model proposed by Nelson (1991). Frs, Nelson assumes ha follows a generalzed error dsrbuon, whle Evews assumes normally dsrbued errors. Second, Nelson s specfcaon for he log condonal varances dffers slghly from he specfcaon above. Nelson (1991) specfcaon for he log condonal varance s saed n Eq.(6). Esmang hs model under he assumpon of normal errors yelds dencal esmaes o hose repored by Evews excep for he nercep erm,, whch dffers by. 1 1 log log 1 (6) 1 1 We examne he predcve power of oupu growh and nflaon on soc reurns and volaly usng GARCH (1,1) or EGARCH (1,1) afer deermned he models for soc reurns. Hamlon and Ln (1996) used Eq.(7) and Eq.(8) o model condonal varance of soc reurns as a funcon of pas squared forecas economc varables. y (7) I 1 1 u ( OupuGrowh) ( Inflaon) (8) 1 Ths paper modfed he model used by Hamlon and Ln (1996), and ncorporaed he model wh hree lags as suggesed by Davs and Kuan (00) because he soc mare reacs o nformaon relavely faser han goods mare. Also, we employed Bollerslev and Wooldrdge s (199) robus varance esmaor o compue asympoc sandard errors snce he resduals may no be condonally normally dsrbued. When he assumpon of condonal normaly does no hold, he ARCH parameer wll sll be conssen, subjec o he mean and varance funcons are correcly specfed. The esmaes of he covarance marx wll no be conssen unless hs opon s specfed. The parameer esmaes s unchanged usng hs opon bu he esmaed covarance marx wll be alered. Hence, he models we employed are as shown n Eq.(9) and Eq.(10). Some dfferences exs beween he presen specfcaon and ha of Hamlon and Ln (1996). Ths paper aes a long-run vew and examnes he mpac of overall oupu volaly on soc mare volaly, bu Hamlon and Ln focused on he mpac of regme changes of recessons on soc mare volaly. Also, hs paper ncludes oupu growh n boh mean and varance equaon. Inflaon varable s ncluded n boh mean and varance equaon o es he valdy of he Adapve Expeced Fsher Effec o buld some nferences abou he cenral behavour. 1 6

7 R I 1 a ( OupuGrowh) b ( Inflaon) (9) u ( OupuGrowh) ( Inflaon) (10) 1 Nex, he Inflaon-Oupu-Ineres Rae-Soc Reurn (IOIS) models as shown n Eq.(11) and Eq.(1) are employed o analyse he effec of nflaon, oupu growh, and neres rae changes on soc reurn and volaly smulaneously. R I 1 1 a ( OupuGrowh) b ( Inflaon) c ( Ineres) (11) u ( OupuGrowh) ( Inflaon) ( Ineres) The specfcaon n Eq.(5) n EGARCH (1,1) model s used should here be he exsence of asymmerc volaly evdence o replace he specfcaon n Eq.(10) and Eq.(1). 1 1 (1) 4. Emprcal Resuls Descrpve Sascs Table repors he descrpve sascs for soc reurn, nflaon, oupu growh and neres rae for all seven counres. Resuls reveal ha he average monhly soc reurns ranged from 0.40% o 1.51%. Phlppnes has he hghes soc reurns wh he hghes sandard devaon (17.66%),.e., hgh reurn s accompaned by hgh rs. The res of he counres end o share abou he same level of varaon wh respec o soc reurns. For nflaon, ranged from 0.09% (Sngapore) o 0.7% (Phlppnes). Resuls ndcae ha he monhly soc reurns volaly and nflaon are hgher for EM han MM on he average (excep for Sngapore). Also, hgh nflaon counry le Phlppnes end o have hgher soc reurns, whle low nflaon counry le Sngapore s assocaed wh relavely lower reurns. In erm of oupu growh, Asa EM s hgher as compared o US and Japan. Oupu growh rae s mos volale n Phlppnes (0.87%), whle s lowes n he US (0.5%). The res of he counres do no appear o dffer much wh respec o oupu devaons. Japan has he hghes average neres rae growh durng he sample perod, wh a negave monhly growh rae of 0.5%, whle Malaysa s experencng he lowes neres rae growh of 0.007%. US, Malaysa and Korea are havng relavely lower devaon, and Japan, Sngapore, Phlppnes, Korea and Inda are havng large devaon wh respec o neres rae. Table : Descrpve Sascs Counry Soc Reurn Inflaon Oupu Growh Ineres Rae Sample Mean Sd Mean Sd Mean Sd Mean Sd Perod 7

8 Devaon Devaon Devaon Devaon Japan M8:1957- M1:007 US M8:1957- M1:007 Sngapore M1:1997- M1:007 Malaysa M1:1980- M1:007 Korea M1:1980- M1:007 Phlppnes M1:1981- M1:007 Inda M1:1960- M1:007 Tme Varyng Volaly The resul of he esmaed coeffcens for he sandard GARCH (1,1) model s repored n Table. All counres show sgnfcan me-varyng volaly n soc reurns. I shows ha he sandard specfcaon of GARCH (1,1) f he counres under sudy. To dagnose f soc reurns s assocaed wh asymmerc volaly, EGARCH (1,1) s employed, and he esmaon resul s repored n Table 4. Resuls reveal ha sx counres are beer fed wh EGARCH (1,1) as compared o he sandard GARCH models, whch mples ha he presen of asymmerc volaly n soc reurns. Those sx counres are Japan, USA, Malaysa, Sngapore, Phlppnes and Inda, whle GARCH (1,1) model s hold for Korea. From Tables and 4, here are sgnfcan evdences o show ha me-varyng volaly on soc reurns for boh MM and EM. Ths resul s conssen wh he clamed made by Beaer and Harvey (1997), Aggarwal e al. (1999), and Davs and Kuan (00) for emergng mare reurns. Table : GARCH (1,1) esmaes for soc reurns Counry Mean Equaon Condonal Varance Equaon Consan Consan Japan * 1.149* * * USA * *** ** * Malaysa *.6784** ** * Sngapore ** ** * Korea ** *** *** * Phlppnes *** * Inda ** * * Noe: Aserss (*, **, ***) denoe sascal sgnfcance a he 1%, 5% and 10% levels respecvely. Table 4: EGARCH (1,1) esmaes for soc reurns Counry Mean Equaon Condonal Varance Equaon Consan Consan Japan * * * *** USA * ** ** * * Malaysa * * ** Sngapore *** ** * *** Korea ** *** * Phlppnes * * ** Inda ** * * Noe: Aserss (*, **, ***) denoe sascal sgnfcance a he 1%, 5% and 10% levels respecvely. 8

9 Table 5: The cumulave mpac of oupu growh and nflaon on soc reurns and volaly ( monh horzon) Counry Reurns Volaly Dagnosc Tess 1 Oupu 1 Inflaon 1 Oupu 1 Inflaon Japan *** ** Q= Q = JB= * ARCH= USA ** * * Q= Q =10.7 JB=5.76* ARCH= Malaysa Q= Q = JB= * ARCH= Sngapore *** Q= Q = JB= ARCH= Korea * *** * Q= Q = JB= ARCH= Phlppnes * 0.056* * Q= Q =.9086 JB=5.4596* ARCH=0.07 Inda ** * Q= 1.01 Q =4.88 JB= ARCH= Noes: F-sascs (Usng Wald-Coeffcen Resrcon) are for he sascal sgnfcance of he sum of hree coeffcens. Q-es s he es for seral correlaon wh lag 1, Q -es s he es for dependency n squared resduals a lag 1, and ARCH s he F-sascs for ARCH LM Tes wh lag 1. Aserss (*, **, ***) denoe sascal sgnfcance a he 1%, 5% and 10% levels respecvely. Predcve Power of Oupu and Inflaon To analyse he predcve power of oupu growh and nflaon on monhly soc reurns and he volaly, boh oupu growh and nflaon are se o be he exogenous varables for he mean and condonal varance smulaneously. The dagnosc ess ndcae no evdence of sgnfcan auocorrelaon and no evdence of dependency n squared resduals for all hese counres. The mpac of changes n oupu growh and nflaon on soc reurns over a hree-monh horzon are repored n Table 5 1. Resuls reveal ha here s sgnfcan predcve power of oupu growh on monhly soc reurns for boh Japan and US. Over a hree-monh perod, a 1% ncrease n oupu growh rae s assocaed wh a cumulave effec of 0.16% rase and 0.56% fall n monhly soc reurn for Japan and US respecvely. 1 Only he resuls wh respec o oupu and nflaon are repored here. Pas soc reurns and he esmaes of he GARCH coeffcens ncludng he coeffcen for dummes are no repored here. 9

10 There s a posve (negave) relaonshp beween oupu growh rae and soc reurn n Japan (US). Posve oupu growh rae can boos up nvesors confdence n he mare. Meanwhle, here s no sgnfcan oupu predcve power on soc reurns n EM. The negave relaon beween nflaon and soc reurn s conssen wh Gregorou e al. s (009) sudy. I s possble when he ransmsson mechansm for real money no nflaon s hrough consumpon growh. In he long run, he moneary expanson on nflaon cancels n response o smlar ncreases n real soc reurns. Tha s o say, consumpons reac posvely o soc reurns, bu hese responses are reduced by he mpac of nflaon. The negave relaon beween oupu growh and soc reurn could be due o emporary hgher level of economc acvy and s expeced o follow rend reverson; causng curren savng reduces soc reurns (Tsouma, 008). There s sgnfcan negave predcve power of nflaon on soc reurns. The mpac of nflaon on soc reurns s sgnfcan only for US (-.09%), Korea (-1.57%) and Phlppnes (-0.41%). Ths mples ha a 1% ncrease n nflaon n US reduces he soc reurns by.09% over a hree-monh perod. Ths resul s also conssen wh Ely and Robnson (1991), Kaul (1987), Soln (198), and Mundell (196). Pgou real wealh effec shows ha he real rae of neres s negavely relaed o expeced nflaon. Progressve axes effec explans he negave mpac of nflaon on soc reurns. Curren reurns depend on fuure cash flows. If fuure ax lables ncrease due o he hgher expecaon of fuure nflaon, wll reduce fuure cash flows and resul n lower soc reurn. For soc reurn volaly, generally he resuls show ha mos counres show sgnfcan mpac of oupu movemens on soc reurn volaly, where Asa EM depcs sronger evdence. Phlppnes (0.%), Korea (0.04%) and Inda (0.0%) show sgnfcan posve mpac of oupu growh on soc reurns volaly, whle sgnfcan negave mpac for Japan (-0.05%) and Sngapore (-0.06%); he laer exhbs hgher volaly as compared o he former (Table ). Ths mples ha MM wh relavely hgher oupu volaly s assocaed wh hgher condonal soc reurns volaly, vce versa; whle he resul s mxed for EM. The effec of nflaon on he condonal soc mare volaly s sgnfcan for US (0.4%), Korea (0.09%), Phlppnes (-1.%) and Inda (0.0%). The resul ndcaes ha he evdence of nflaon volaly on soc reurn volaly s relavely srong for Asa EM. Low nflaon raes counres end o have unrecepve effec on volaly han hgher nflaon raes counres. Hgh nflaon rae counry le Phlppnes adversely affeced soc mare volaly. Table 6: The cumulave mpac of oupu growh, nflaon and neres rae on soc reurns and volaly ( monh horzon) Counry Reurns Volaly Dagnosc Tess Oupu Inflaon Ineres rae Oupu Inflaon Ineres rae Japan ** *** Q=1.0 10

11 Q = JB= * ARCH= USA *** * *** * ** Q=11.48 Q = JB= * ARCH= Malaysa *** ** Q= Q = JB= ** ARCH= Sngapore *** * Q=11.65 Q = JB= ARCH= Korea * *** * Q= 5.77 Q = JB= ARCH= Phlppnes * * * * * ** Q= Q =6.69 JB=.0956* ARCH= Inda * Q= Q =6.674 JB= ARCH= Noes: F-sascs (Usng Wald-Coeffcen Resrcon) are for he sascal sgnfcance of he sum of hree coeffcens. Q-es s he es for seral correlaon wh lag 1, Q -es s he es for dependency n squared resduals a lag 1, and ARCH s he F-sascs for ARCH LM Tes wh lag 1. Aserss (*, **, ***) denoe sascal sgnfcance a he 1%, 5% and 10% levels respecvely. Inflaon-Oupu Growh-Ineres Rae-Soc Reurn (IOIS) Model By ncludng neres rae changes, mproves he predcve power of oupu growh on soc reurns. In erms of he mpac of oupu growh on soc reurns, here s mprovemen n IOIS model (Table 6) as compared o he prevous model (Table 5). There s no auocorrelaon paern n he seres for IOIS model, as shown from Q sascs, Q sascs and ARCH ess. Four counres show sgnfcan evdence where Japan (0.14%) and Phlppnes (0.7%) demonsrae posve relaon beween oupu growh and soc reurns, and US and Malaysa (-0.1%) llusrae negave mpac. Posve oupu growh would cause explc earnng growh and resul n hgher expeced fuure dvdends and ulmaely ncrease soc reurns. Meanwhle, accordng o Ang (008), economc booms encourage he adopon of a rser behavour and encourage speculave economc acves whch may creae over-leveraged suaon. The nsably of soc speculaon regardng over-leveraged suaons can have severe negave consequences for an economy due o psychologcal facors. In erm of he mpac of nflaon on soc reurns, resuls revealed ha here s no sgnfcan change n he IOIS Model as compared o he prevous model. US, Korea and Phlppnes have sgnfcan negave relaon beween nflaon and soc reurns. If he governmen s no able o oban suffcen revenue o fnance s szeable expendures, whch wll probably happen durng economc crss and soc reurn usually drop, he expeced nflaon would rse f he defcs are monesed, and resul n negave relaonshp beween nflaon and soc reurns. Ou of seven counres, only Sngapore and Phlppnes show sgnfcan negave relaonshp beween neres rae changes and soc reurns. The ncrease n neres raes for mere reasons of arbrage means hgher 11

12 fnancng cos for nvesmen n producon and soc nvesmen. Hgher nvesmen cos wll cause a fall n fuure earnng due o he plunge n fuure producon, whch wll lead o a reducon n fuure cash flows and hence leadng o a reducon n soc reurns. Besdes ha, hgher neres rae wll lead o hgher cos o fnance soc nvesmen, hence reduce he wllngness of nvesor n soc nvesmen and fall n soc prce. The evdence of oupu growh on soc reurn volaly n IOIS Model s relavely srong wh fve counres ou of seven counres show sgnfcan resuls. US (0.06%), Korea (0.04%) and Phlppnes (0.%) show posve relaon beween oupu growh on soc reurn volaly, and Japan (-0.04%) and Sngapore (-0.09%) show negave relaons. Meanwhle, he predcve power of nflaon on soc reurn volaly n IOIS Model s an wh he resul n Table 5. I s noeworhy ha Phlppnes exhbs a negave relaonshp beween nflaon and soc reurn volaly, whle USA, Korea and Inda evdenly show posve relaon. The amplude of nflaon on soc reurn volaly s subsanal for Phlppnes. Therefore, polcy maer should ae precauon seps o manage nflaon due o s large mpac on soc reurn volaly. On he oher hand, he predcve power of neres rae changes on soc reurn volaly s moderae. US and Malaysa show negave relaon. Such negave relaon suggesng ha he removal of neres raes conrols may promoe fnancal developmen. Only Phlppnes shows posve relaon beween neres rae and soc volaly, suggesng ha fnancal lberalsaon appears o have posve effec on asse reurn progress. However, he amplude of he mpac s relavely small. 5. Conclusons Usng GARCH and EGARCH models, hs paper examnes he predcve power of oupu growh and nflaon on soc reurn and s volaly. Resuls reveal srong evdence of oupu growh and nflaon on soc reurn volaly. The resuls have proved a pror ha here s evdence where more evdences were showed by Asa fnancal crss counres as compared o US and Japan. The evdence of oupu growh on soc reurn s exremely dfferen beween MM and Asa crss EM as boh US and Japan show sgnfcan evdence ha oupu growh acs as an mporan deermnan o deermne soc reurns, bu none of he EM under sudy reveals sgnfcan resuls. I s noeworhy ha he evdence of predcve power of nflaon on soc reurn does no suppor he Adapve Fsher effec n soc reurn. Ths could be jusfed usng Pgou real wealh effec. Progressve axes effec mgh explan he negave mpac of nflaon on soc reurns. Generally, he negave mpac of nflaon o predc soc reurn s sgnfcan n US, Korea and Phlppnes. Resuls reveal ha four ou of seven counres show sgnfcan evdence of he predcve power of nflaon on soc reurns volaly. Hgh nflaon nfluences soc reurns volaly n Phlppnes. Ths resul provdes mporan nsgh for polcy maer o conrol nflaon o reduce he soc reurn volaly snce hgher volaly means hgher rs for nvesor. The resul from IOIS Model shows ha he ncluson of neres rae changes mproves he predcon power of he oupu growh on he soc reurn. Japan and Phlppnes 1

13 show posve relaon n whch posve oupu growh wll cause posve earnng growh and brng beer expeced fuure dvdends and ulmaely cause he soc reurn o ncrease. Even wh he ncluson of neres rae changes, resuls do no suppor Fsher Effec. The negave relaonshp beween nflaon and soc reurn mgh be caused by he defc fscal polcy carred ou by he governmen. If he governmen fals o oban suffcen revenue o fnance s large expendures, he expeced nflaon wll ncrease and brng negave effec on soc reurn. The resul also proves ha neres rae changes do have some sgnfcan nfluences on soc reurn volaly n US, Malaysa and Phlppnes alhough he drecon of mpac s ambguous. For fuure sudy, here s much room for mprovemen o examne oher facors ha nfluence he soc reurn and s volaly such as money supply growh rae, savng rae, ncome per capa, polcal sably, soc mare regulaon and ec. One may exend he sample perod across he sample counres o mprove he predcve power of he model. References Aggarwal, R., Inclan, C. and Leal, R. (1999) Volaly n emergng soc mares. Journal of Fnancal and Quanave Analyss, 4(1), -55. Ang, J.B. (008) Wha are he mechansms lnng fnancal developmen and economc growh n Malaysa, Economc Modellng, 5, 8-5. Balvers, R.J., Cosmano, T.F., and McDonald, B. (1990) Predcng soc reurns n an effcen mare. Journal of Fnance, 45(4), Beaer, G. and Harvey, C. R. (1997) Emergng mare volaly. Journal of Fnancal Economcs, 4, Beaer, G. and Harvey, C.R. (004) A chronology of mporan fnancal, economc and polcal evens n emergng mares. hp:// Bnswanger, M. (000) Soc mare booms and real economc acvy: s hs me dfferen? Inernaonal Revew of Economcs and Fnance, 9, Bollerslev, T. (1986) Generalzed Auoregresve Condonal Heerosedascy. Journal of Economerc, 1, Bollerslev, T. and Wooldrdge, J. M. (199) Quas-maxmum lelhood esmaon and nference n dynamc models wh me varyng covarances. Economerc Revews, 11, Braun, P. A., Nelson, D. B. and Suner, A. M. (1995) Good news, bad news, volaly, and beas. Journal of Fnance, 1(5), Campbell, J. Y. and Henschel, L. (199) No news s good news: an asymmerc model of changng volaly n soc reurns. Journal of Fnancal Economcs, 1,

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