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Macroeconomic factors affect stock returns.

Examine How Macroeconomic Factors Affect Stock Returns

examine how macroeconomic factors affect stock returns.
Order Instructions:
The goal of the project: We examine how macroeconomic factors affect stock returns.
Empirically, we can test the following model;
Rt= ?0 + ?1*Market Indext-1+ ?2*Inflationt-1+ ?3*GDP Growtht-1+ ?4*TERMt-1+ ?5*RISKt-1+?


1. Dependent variable: firms� stock returns
I posted firms� stock returns in three industries (air, auto, and computer) to Blackboard. You can analyze any firm as you wish. You can pick multiple firms from three different industries, or a single firm from a specific industry.
Variable Explanations
DATE: the end of trading date at each month
COMNAM: Company name
EXCHCD: Exchange code (1: NYSE, 2: AMEX, and 3:NASDAQ)
HSICCD: Industry classification (e.g., The SIC 4512 represents an airline industry.
PRC: Stock price at the end of each month�s trading date
RET: Stock returns at the end of each month�s trading date
SHROUT: shares outstanding
VWRETD: Market index
2. Independent variables: macroeconomic variables
* The Source of data: http://research.stlouisfed.org/fred2/tags/series
Download data as long as we believe that variables may affect stock returns.
There are some candidates for independent variables.
Market Index=VWRETD, and Firm Size= PRC*SHROUT
Inflation= log (CPIt / CPIt-1), and GDP Growth=log (GDPt / GDPt-1)
TERM= 10-year T/B � 3-month T/B, and RISK= BAAt � 10-year T/B?
Questions
1) Report summary statistics (n, mean, median, standard deviation, min, max) of your picked variables.
2)Why do you include such independent variables? Give me a brief explanation.
3) Run a regression and report coefficients and t-statistics for the explanatory variables.
4) Interpret coefficients of each variable. Compare it with your prediction
5) What is your investment strategy based on your findings?
* To obtain full credit (20 points), you need to submit it by July 8th, 2014.Grade below 10 points will be counted as zero.
* The minimum requirement is 5 different firms and 5 independent variables.
* TERM and RISK should be included as independent variables.
* If you need a reference, please look at the paper written by Nai-Fu Chen, Richard Roll, and Stephen A. Ross. The title is �Economic Forces and the Stock Market (Journal of Business, 1986)�.

Abstract

There are many macroeconomic factors that affect the stock market globally. Inflation and deflation have adverse financial effects on a company’s profitability which subsequently affect the stock market. The rate of increment on the prices of goods and other services constitutes inflation besides the increase in the cost of transportation and manufacturing expenses. (Swann, 2009) The stock market responds powerfully when the rate of inflation is low and weakens when it increases as most companies reduce their expenditures because of high cost of goods and services and the general money in economy reduces which results in reduced activities at the stock market. Deflation in most quarters is regarded as a sign of a weak economy as it also leads to a decrease in the stock market. (Chen, Roll and Ross, 1986)

The interest rates are established and monitored by Federal Reserve Board. Higher rates of interests are caused by the expensive nature of borrowing money. Money becomes too expensive to borrow. To subsidize their high rates of interests, most companies may opt to lay off workers and reduce expenditures on other goods. Higher rates of interests imply that even companies will not be comfortable when borrowing as the rate of interests becomes exorbitant and their income will also be affected. (Cairns, 2004) When the income of listed companies reduces then the investments in the stock market is also affected negatively.

1

Sun Microsystems    
 PRCRETSHROUTWRETD
n132132133133
Mean22.360210.00174724471230.002766
Median114.34-0.08963955344.5-0.184
STD34.0980.1625712017970.048607
Min2.59-0.39474385583-0.18462
Max132.250.56410336020000.110533
FRANKLIN ELCTRONIC PUBLISHS    
 PRCRETSHROUTWRETD
n133133134134
Mean3.1821470.0135898063.910.003009
Median9.4450060.0665788504.8440.053974
STD4.0800060.21349402.34380.053359
Min-3.845-0.464297818-0.18462
Max11.93751.14143483870.110533
SILICON GRAPHICS INC    
 PRCRETSHROUTWRETD
n82828383
Mean4.0811590.025353211362.60.003827
Median14.697410.253384439218.60.012599
STD14.066120.52192557156.860.041823
Min0.44-0.54676182872-0.10253
Max20.56252.7826092682720.083911
APPLE COMPUTER INC    
 PRCRETSHROUTWRETD
n96969696
Mean43.1370.035008438980.50.004941
Median63.01375-0.03415498318.50.024586
STD30.866980.0569315118060.019459
Min14.14-0.57744136417-0.10253
Max135.81250.4537828602200.083911
UAL CORP    
 PRCRETSHROUTWRETD
n51515252
Mean36.4751-0.0596356649.73-0.00232
Median62.250.042932743270.060554
STD43.423430.18749232795.610.019813
Min0.84-0.5176549792-0.10253
Max80.750.326258995060.083911
FORD MOTOR CO    
 PRCRETSHROUTWRETD
n144144144144
Mean17.047260.00995819617210.004096
Median39.113750.05401122704810.053095
STD31.570550.0009715999310.02086
Min16.790.05332511391590.038345
Max63.93751.27376434018030.110533

2. Independent variables are included as they determine or influence other variables. An independent variable when manipulated determines or influences the change in the other dependent variable. This study seeks to determine if a relationship exists between the returns of the stock market and the macro economic factors that may affect the overall performance of the stock market.

3.  Ford Motor Co

SUMMARY OUTPUT
Regression Statistics
Multiple R0.4995218
R Square0.249522
Adjusted R Square0.244237
Standard Error0.148835
Observations144
ANOVA
 dfSSMSFSignificance F
Regression11.045851.0458547.2131.849E-10
Residual1423.145560.02215
Total1434.19142   
 CoefficientStandard errort StatP-valueLower 95%Upper 95%Lower 95.0%Upper 95.0%
Intercept0.00290.01240.22900.8192-0.02180.0275-0.02180.0275
VWRETD1.73540.25266.87120.00001.23612.23471.23612.2347

Franklin Electronic Publish Inc

SUMMARY OUTPUT
Regression Statistics
Multiple R0.31
R Square0.09
Adjusted R Square0.09
Standard Error0.23
Observations133.00
ANOVA
 dfSSMSFSig F
Regression10.7150.71513.5540.000
Residual1316.9150.053
Total1327.631   
 CoeffStd Errort StatP-valueLower 95%Upper 95%Lower 95.0%Upper 95.0%
Intercept0.00940.0199550.471060.6383832-0.030.048876-0.030080.048876
VWRETD1.51470.4114163.681570.00033770.70082.3285320.7007762.328532

UAL Corp

SUMMARY OUTPUT
Regression Statistics
Multiple R0.552
R Square0.304
Adjusted R Square0.290
Standard Error0.156
Observations51.000
ANOVA
 dfSSMSFSign f
Regression10.5210.52121.4420.000
Residual491.1910.024
Total501.712   
 CoeffStd errort StatP-valueLower 95%Upper 95%Lower 95.0%Upper 95.0%
Intercept-0.0520.022-2.3720.022-0.096-0.008-0.096-0.008
VWRETD1.9330.4184.6310.0001.0942.7721.0942.772

Sun Microsystems

Regression Statistics
Multiple R0.664
R Square0.441
Adjusted  R Square0.437
Standard Error0.122
Observations132.000
ANOVA
 dfSSMSFSignificance F
Regression11.5271.527102.63.92E-18
Residual1301.9350.015
Total1313.462   
 CoefficiStd Errort StatP-valueLower 95%Upper 95%Lower 95.0%Upper 95.0%
Intercept-0.0050.011-0.4760.635-0.0260.016-0.0260.016
VWRETD2.2190.21910.1300.0001.7852.6521.7852.652

Silicon

Regression Statistics
Multiple R0.260
R Square0.067
Adjusted R Square0.056
Standard Error0.403
Observations82.00
ANOVA
 dfSSMSFSig  F
Regression10.9390.9395.7870.018
Residual8012.970.162
Total8113.91   
 CoeStd errort StatP-valueLower 95%Upper 95%Lower 95.0%Upper 95.0%
Intercept0.0170.0450.3910.697-0.0710.106-0.0710.106
VWRETD2.3380.9722.4060.0180.4044.2720.4044.272

4. Interpretation

Ford Motor Co.

The thesis of the study is to establish if a relationship exists between the performance of individual stocks belonging to different companies and the performance of the stock market and if the stock market can be affected by macroeconomic factors such as real GDP growth, inflation, interest rates or unemployment.

P-Value – 0.8192 It indicates that the significant relationship between the returns of the market and the performance of the markets index is very low.

Coefficient – 1.7354 The slope is of the graph is positive which indicates that the stock returns increases relatively to the increase in the stock index.

R square – 0.2495 The R square measures the strength of the relationship, how strong or weak the relationship is. In this case we can conclude that the variability of the stock market index explains only 24.95% of the stock returns.

Franklin Electronic Publish Inc

P-Value – 0.6383 It indicates that the significant relationship between the returns of the market and the performance of the markets index is very low.

Coefficient – 1.514 The slope is of the graph is positive which indicates that the stock returns increases relatively to the increase in the stock index.

R square – 0.09 The R square measures the strength of the relationship, how strong or weak the relationship is. In this case we can conclude that the variability of the stock market index explains only 9 % of the stock returns.

UAL Corp

P-Value – 0.022 It indicates that the significant relationship between the returns of the market and the performance of the markets index is very low.

Coefficient – 1.933 The slope is of the graph is positive which indicates that the stock returns increases relatively to the increase in the stock index.

R square – 0.304 The R square measures the strength of the relationship, how strong or weak the relationship is. In this case we can conclude that the variability of the stock market index explains only 30.4% of the stock returns.

Sun Microsystems

P-Value – 0.635 It indicates that the significant relationship between the returns of the market and the performance of the markets index is very low.

Coefficient – 2.219 The slope is of the graph is positive which indicates that the stock returns increases relatively to the increase in the stock index.

R square – 0.441 The R square measures the strength of the relationship, how strong or weak the relationship is. In this case we can conclude that the variability of the stock market index explains only 44.1% of the stock returns. (Draper & Smith, 1998)

Silicon

P-Value – 0.697 It indicates that the significant relationship between the returns of the market and the performance of the markets index is very low.

Coefficient – 2.338 The slope is of the graph is positive which indicates that the stock returns increases relatively to the increase in the stock index.

R square – 0.067 The R square measures the strength of the relationship, how strong or weak the relationship is. In this case we can conclude that the variability of the stock market index explains only 6.7% of the stock returns.

                                 The Relationship Between RET and WRETD

My findings that are based on the graph above indicate that there is no relationship between the returns on the stock market and the general performance of the stock index. My predictions were that the relationship that exists between the stock market and the performance of the individual stocks is very limited.

Macro-Economic Analysis

                              USA Macro-Economic Indicators

Source: http://research.stlouisfed.org/fred2/tags/series?t=&pageID=9

                  Source: http://research.stlouisfed.org/publications/iet/

Source :http://research.stlouisfed.org/publications/iet/

The analysis from the above graphs indicate that there is a significant relationship between the returns on company stocks and the macro economic factors such as real GDP growth, unemployment level and inflation rate. When the macro-economic factors in the growing are positively improving then most company stocks post good returns. When the factors are negative, for instance when the rates of inflation and unemployment are so high then the stock returns also post low returns. In the year 2008, during the global economic crisis, most economies registered negative real GDP growth, the unemployment levels were so high and inflation rates were at their peak in most countries. The stock returns for most countries were also affected negatively and they registered a drop in their earnings. When inflation rates are so high most companies lay off workers to reduce expenses and decrease borrowings due to the high cost of borrowing while unemployment levels increases, the real GDP growth also decreases due to reduced circulation of money in the economy. (Swann, 2009)  The company stocks are calculated and classified as per its volatility and in accordance with the stock market risks and beta. During the economic crisis of 2008, the volatility of most stocks were at their highest together with the term of most bonds.

5. My investment strategy would be to invest as per the performance of the individual company stock and not the general performance of the stock market.

References

Cairns, J (2004). Interest Rate Models – An Introduction. Princeton University Press.

Chen, N., Roll, R. and Ross, S.A. (1986) Economic Forces and the Stock Market. Journal of Business.

Draper, N.R., Smith, H. (1998). Applied Regression Analysis (3rd Ed.). John Wiley.

Sullivan, Sheffrin, S (2003). Economics: Principles in action. Upper Saddle River, New Jersey

Pearson, Prentice Hall.

Swann, C. (2009) “GDP and the Economy – Advance Estimates for the Second Quarter of

2009,” Survey of Current Business, August 2009.

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