A tale of tails :New evidence on the growth-return nexus

Existing theoretical models predict that asset prices should be strongly related to economic fundamentals. Yet empirical studies usually find a weak correlation. We find that the stock market declines tend to be followed by slower economic growth within two-to-four quarters. However, the relationship is not linear as it tends to be weaker when market prices increase. This result holds for most of 20, mostly developed, countries in our sample. Controlling for the development in interest rates does not change our conclusions. Therefore, we provide new evidence that economic fundamentals and stock prices are related in quantiles.

Automated summary

Studies have found that stock market declines tend to lead to slower economic growth in the following two to four quarters. However, this relationship is not linear, as it weakens when market prices increase. This conclusion holds true for most developed countries.