The Stock Market, the Real Economy and Contagion

In this paper we analyze the link between stock market performance and macroe conomic performance for a large number of countries. We study the short-run and long-run relationships and find that stock market returns do not coherently predict future macroeconomic changes for the majority of countries, i.e. the estimates vary considerably both across prediction horizons and across countries. Moreover, we test whether the financial and real economy dynamic linkages increased in the financial crisis in 2008 implying “macro-financial” contagion. The crisis-specific analysis of macro-financial linkages broadens the perspective of existing studies of financial contagion. Our findings indicate that the stock market does not merely reflect future economic conditions but also influences them justifying policy responses as witnessed during the 2008 financial and economic crisis.