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The role of term spread and pattern changes in predicting stock returns and volatility of the United Kingdom: Evidence from a nonparametric causality-in-quantiles test using over 250 years of data

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  • Gupta, Rangan
  • Risse, Marian
  • Volkman, David A.
  • Wohar, Mark E.

Abstract

Given the existence of nonlinear relationship between equity premium and term spread, as well as pattern changes and the interaction of pattern changes with the term-spread and changes in the shape of the yield curve, we use a nonparametric k-th order causality-in-quantiles test to predict the movement in excess returns and volatility based on changes in the shape of the yield curve. With the test applied to over 250 years of monthly data for the UK covering the period 1753:08 to 2017:02, we find that pattern changes and the interaction of pattern changes with the term-spread, besides the term spread itself, tends to also play an important role in predicting volatility at the upper end of its conditional distribution. In addition, the effect on excess returns from term spread, pattern changes and the interaction is found to have improved markedly over time, barring at the conditional median of the equity premium. Finally, comparisons are made with historical data of the US and South Africa, and implications of our results are discussed.

Suggested Citation

  • Gupta, Rangan & Risse, Marian & Volkman, David A. & Wohar, Mark E., 2019. "The role of term spread and pattern changes in predicting stock returns and volatility of the United Kingdom: Evidence from a nonparametric causality-in-quantiles test using over 250 years of data," The North American Journal of Economics and Finance, Elsevier, vol. 47(C), pages 391-405.
    • Handle: RePEc:eee:ecofin:v:47:y:2019:i:c:p:391-405
    DOI: 10.1016/j.najef.2018.05.006
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    More about this item

    Keywords

    Stock returns; Volatility; Yield curve changes; Conditional term spreads; Nonparametric causality-in-quantiles test;
    All these keywords.

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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