Canadian stock returns and macroeconomic innovations

Abstract

The study attempts to determine the impact of macroeconomic innovations on monthly Canadian stock returns. In the absence of media expert forecasts on the relevant macroeconomic variables, innovations are estimated by using a three-variable VAR the model. In addition to these three variables, viz. unexpected inflation, unexpected unemployment and unexpected growth in real money supply, the model incorporates variables related to the Bank of Canada Canada Rate, term structure of interest rates and the stock market crash of 1987. In order to avoid the statistical problems associated with using lagged innovations as regressors Instrumental Variables approach is used to estimate the models The results indicate that, on average, the innovations explained third of the variation in the portfolio returns Introduction of lagged monetary variable appears to make the coefficients more significant. The results, however, are not as vincing as their U.S. counterparts.