Business Cycle Asymmetry and the Stock Market

We present and estimate models of an asymmetric relationship between CRSP stock index returns and the U.S. unemployment rate. Based on the Akaike Information Criterion, conventional linear time series models are improved by allowing asymmetric responses. Our results show that negative stock returns are quickly followed by sharp increases in unemployment, while more gradual unemployment declines follow positive stock returns. According to our forecasting model, the unemployment rate rises by 1.12 percentage points during the 12 months after a 10 percent stock decline. Because macroeconomics forecasters have been unable to reliably predict downturns, these findings may provide a useful contribution