What is the link between stock markets and the macroeconomy

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School of Business | Master's thesis
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Date

2025-12-31

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Mcode

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Master's Programme in Finance
Rahoituksen maisteriohjelma

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en

Pages

72

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Abstract

This thesis examines the relationship between stock markets and the macroeconomy, focusing on whether and how key macroeconomic variables predict stock returns and influence market volatility in the US, Germany, France, and Italy over the period 2002-2022. A classic question in finance is revisited: Are stock markets tied to the real economy, or do they move largely independently? I tried to address this by analyzing three important macro variables – dividend yields, term spreads, industrial production growth, and their predictive power for stock returns, at the same time, the impact of macroeconomic shocks on stock market volatility. Using monthly data on major stock indices (in our case they were – S&P 500, DAX, CAC 40, FTSE MIB) and macro indicators from Capital IQ, Bloomberg, FRED, OECD, and World Bank, I used Autoregressive (AR) models and Vector Autoregression (VAR) to assess both short-run and long-run dynamics. My findings indicate that macroeconomic factors have a limited but detectable influence on stock market performance. In in-sample forecasts, classic predictors like dividend yield and term spread explain only a very small fraction (approximately 2-8%) of monthly stock return variation, with the US market showing slightly stronger links than the European markets. Impulse response analysis shows that positive macroeconomic shocks (for example an increase in industrial production) lead to modest stock return increases and reduced volatility over longer horizons, whereas adverse shocks raise short-run market volatility. However, these effects differ by country: the US stock market exhibits more pronounced macro-driven predictability and volatility responses, while the Europe: Germany, France, and Italy show weaker and more delayed reactions. The multi-country comparison and inclusion of recent crisis periods (especially the COVID-19 shock) underscore that the stock market-economy relationship can vary significantly across economic regimes. Overall, the results support the view that stock markets are forward-looking and only partially connected to current macroeconomic conditions – a high degree of independence prevails in the short run, but fundamental economic trends do eventually impart some influence. The thesis contributes to the literature by providing an up to date, most importantly, cross-country empirical assessment, incorporating the tumultuous post-2020 period. Practical implications suggest caution in relying on macro indicators alone for equity prediction and underscore the importance of global factors and investor sentiment. The thesis concludes with a discussion of limitations (such as low predictive R² and potential structural breaks) and offers my recommendations for future research, including exploring additional variables (inflation, sentiment, exchange rates), non-linear modeling (regime-switching), and extending analysis to emerging markets to test the generality of these findings.

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Nyberg, Peter

Keywords

stock returns, macroeconomic indicators, predictability, volatility, VAR, international comparison

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https://urn.fi/URN:NBN:fi:aalto-202601151266

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[gradu] Kauppakorkeakoulu / BIZ