Stock Market Returns, Expected Returns, and Economic Fundamentals in an Emerging Market: The Case of Korea

Publication Type

Journal Article

Publication Date

1997

Abstract

This paper investigates the feedback relationship between stock market returnsand economic fundamentals in an emerging market. Starting from an intertemporalconsumption-based CAPM (CCAPM), we obtain a restricted VAR model for stockreturns and macroeconomic variables. We then apply this model to Korea and findstatistically significant departures from the restrictions implied by CCAPM.Consequently, an unrestricted VAR model is used to analyze the variations of expectedand unexpected returns in the Korean stock market. It is shown that the expectedmarket returns vary with a set of macroeconomic variables, and that thepredictable component is substantial. Reflecting richer dynamics in the data,relative to the usual single equation modeling in the literature, the estimatedVAR model shows considerable predictive ability for both real economic activityand real returns. Using the model for a variance decomposition of unexpectedreturns, we find that, although we cannot directly observe the market's revisionof expected future dividend growth, we can estimate a large part of therevision with the news in the expected industry output growth from our VAR model.Finally, we also find that economic fundamentals can explain only a smallportion of the variation in unexpected returns in the Korean stock market.

Discipline

Economics

Research Areas

Econometrics

Publication

Asia-Pacific Financial Markets

Volume

4

Issue

2

First Page

147

Last Page

169

ISSN

1573-6946

Identifier

10.1023/a:1009673814889

Publisher

Kluwer

Additional URL

https://doi.org/10.1023/a:1009673814889

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