Stock return predictability & output, export and import

Signe Nielsen

Student thesis: Master thesis


This master’s thesis investigates the ability of output, export and import to predict the stock return over long horizons and it aims to estimate this predictability both in- and out-ofsample. Theoretically, the current thesis is founded on the works of Fama & French (1988) and Rangvid (2006). The theoretical idea behind stock return predictability using financial or macroeconomic ratios is that if the stock price is high relative to a given level of output, the investors are willing to pay a high price for the stocks because they expect one of two things to happen in the future, when ruling out bubbles. Either the output will be high due to good economic performing in terms of production or the stock returns rates will be low due to lower required rates of return. The effect will be the same for export, whereas high import compared with stock prices will predict low future import growth or low stock returns. The stock return predictability is investigated by regressing the price-output, price-export or price-import ratios, respectively on the quarterly stock returns summed over 4, 12 or 20 quarters. The countries investigated in the thesis are Denmark, The Netherlands, France and United Kingdom. These countries represent two small and to large countries, since the stock returns in the small countries may be assumed to be more influenced by the export and import due to the fact that their economies can be seen as more open. The in-sample regression for the period 1970-1999 shows high predictability power, since the R2-values are high and the coefficients are very significant using heteroscedasticity and autocorrelation corrected standard errors. All countries and ratios have similar predictive power, except that prediction for The Netherlands seems to perform slightly inferior to the prediction for the other countries. The robustness tests reveal that the results are robust for Denmark and not for United Kingdom. The out-of-sample testing from 2000-2010 reveals that the predictability of the stock return by the ratios is inferior to the stock return predictability by the random walk; hence the results cannot be used by the real time investors.

EducationsMSc in Applied Economics and Finance, (Graduate Programme) Final Thesis
Publication date2010
Number of pages93