Economic Forces in Stock Returns

ArXiv ID: 2401.04132 “View on arXiv”

Authors: Unknown

Abstract

When analyzing the components influencing the stock prices, it is commonly believed that economic activities play an important role. More specifically, asset prices are more sensitive to the systematic economic news that impose a pervasive effect on the whole market. Moreover, the investors will not be rewarded for bearing idiosyncratic risks as such risks are diversifiable. In the paper Economic Forces and the Stock Market 1986, the authors introduced an attribution model to identify the specific systematic economic forces influencing the market. They first defined and examined five classic factors from previous research papers: Industrial Production, Unanticipated Inflation, Change in Expected Inflation, Risk Premia, and The Term Structure. By adding in new factors, the Market Indices, Consumptions and Oil Prices, one by one, they examined the significant contribution of each factor to the stock return. The paper concluded that the stock returns are exposed to the systematic economic news, and they are priced with respect to their risk exposure. Also, the significant factors can be identified by simply adopting their model. Driven by such motivation, we conduct an attribution analysis based on the general framework of their model to further prove the importance of the economic factors and identify the specific identity of significant factors.

Keywords: Factor Analysis, Asset Pricing, Systematic Risk, Economic Forces, Stock Return Attribution, Equities

Complexity vs Empirical Score

• Math Complexity: 3.5/10
• Empirical Rigor: 7.0/10
• Quadrant: Street Traders
• Why: The paper uses standard OLS regression with basic economic factor definitions and data preprocessing, resulting in low-to-moderate math complexity. However, it demonstrates high empirical rigor through detailed data sourcing (FRED, Yahoo Finance), statistical checks (normality, multicollinearity, autocorrelation), and model validation steps, making it backtest-ready.

  flowchart TD
    A["Research Goal:<br>Identify systematic economic forces<br>driving stock returns"] --> B["Methodology:<br>Factor Attribution Analysis<br>based on Chen, Roll & Ross 1986"]
    
    B --> C["Data Collection:<br>Stock Returns<br>+ Economic Indicators"]
    
    C --> D["Core Process:<br>Regression Analysis<br>to test factor significance"]
    
    D --> E["Stepwise Analysis:<br>Add factors one-by-one<br>to identify key drivers"]
    
    E --> F{"Findings/Outcomes"}
    
    F --> G["Stock returns are exposed to<br>systematic economic news"]
    F --> H["Significant factors priced<br>by risk exposure"]
    F --> I["Model enables identification<br>of key economic forces"]
    
    G --> J
    H --> J
    I --> J
    
    J["Conclusion:<br>Systematic economic forces<br>are the primary priced risk factors"]