Role of Share Market

The Role of Stock Markets vs. the Term Spread in Forecasting

Macrovariables in Finland

Kuosmanen, Petri*& Juuso Vataja*ƒx

*University of Vaasa, Department of Economics. Box 700, 65101 Vaasa, Finland.

**Jyvaskyla University School of Business and Economics. Box 35, 40014 University of

Jyvaskyla and University of Vaasa, Department of Economics. Box 700, 65101 Vaasa, Finland.

ABSTRACT

A substantial body of stylized facts and empirical evidence exists regarding the

relationships between financial variables and the macroeconomy in the United States.

However, the question of whether this evidence is consistent with the cases of small

open economies is less known. This paper focuses on the forecasting content of stock

returns and volatility versus the term spread for GDP, private consumption, industrial

production and the inflation rate in Finland.

Our results suggest that during normal times, the term spread is a much better

tool than stock market variables for predicting real activity. However, during

exceptional times, such as the recent financial crisis, the forecast performance is

improved by combining the term spread and the stock market information.

JEL classification: E37, E44, E47

KEY WORDS: Term spread, Stock market, Forecasting, Macroeconomy.

**Corresponding author: Juuso Vataja, Dept of Economics, Box 700, FIN-65101 Vaasa, Finland. E-mail:

jpv@uwasa.fi. Phone: +358 6 324 8525. Fax: +358 6 324 8171.

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1. INTRODUCTION

Because stock returns are forward looking and are related to the future state of the

economy, they also constitute potential predictors of real economic activity and inflation. The

stock market is easy to observe, it is an excellent aggregator of information, and it reacts to

news vigorously and with short delay. Indeed, if investors strongly enough believe that a

recession is imminent, the stock market will not hesitate to send such a signal. Consequently,

the recession will likely not wait very long either. However,...