**1. Introduction**

Fluctuations of stock returns are highly correlated with economic activities. Generally speaking, the reason why the stock market is called the economy showcase is that the current‐period stock return could be viewed as a leading indicator of the economic growth in the future. To some extent, most stock markets are efficient. In an efficient stock market, the current stock price reveals the discounted value of future dividends and capital returns. The current stock price also reflects the investors' expectations of the future of the economy. Therefore, from the macroeconomics view point, the stock market reveals the economic trend of the country. On the field studying the relationship between the stock return and economic growth, in the beginning, most researches use countries such as United States [1, 2], Canada [3, 4], or G7 countries [5, 6] as samples. Later on, members of European Union, members of the Organization

© 2016 The Author(s). Licensee InTech. This chapter is distributed under the terms of the Creative Commons Attribution License (http://creativecommons.org/licenses/by/3.0), which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. © 2016 The Author(s). Licensee InTech. This chapter is distributed under the terms of the Creative Commons Attribution License (http://creativecommons.org/licenses/by/3.0), which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited.

for Economic Cooperation and Development (OECD), or the Asian emerging markets (such as Singapore, Korea, the Philippines, Malaysia, Indonesia, and Taiwan) are included as sample countries as well. Research examples include in [7–11]. Most of these studies find that the relationship between the stock return and economic growth is statistically significant.

The main focus of this study is to investigate whether the relationship between the stock return and economic growth would be the same for countries with different development levels in the depression and recovery subperiods.1 This study employs a 26‐country sample; the sample period is from the first quarter of 1982 to the fourth quarter of 2009, longer than that of [9].2 The new current depth of recession (NCDR) indicator proposed by Bradley and Jansen [12] is used here as the switched factors to capture the subperiods in the recession period.

In researches using the nonlinear model to study the relationship between the stock return and economic growth, authors often construct two regimes to divide the business cycle into two periods, the expansionary and recession periods. For example, Henry et al. [9] argue that output is characterized by asymmetry—the so‐called bounce‐back effect.3 In that chapter, the CDR is used as a proxy variable to examine the significance of the bounce‐back effect and to divide between the expansionary and recession periods for the nonlinear panel data model. The changes of the relationship between the stock return and output growth in the expan‐ sionary and recession periods are used to examine whether the relationship would be impacted by the business cycle.

However, no study has touched the topic whether the recession period contains other impor‐ tant information that can be used to examine the relationship between the stock return and economic growth. Domain and Louton [2], Henry and Olekalns [13], and Henry et al. [9] find that the relationship is significantly positive only in the recession period, but the authors do not explain the reasons for this outcome. Beaudry and Koop [14], Henry and Olekalns [13], and Henry et al. [9] argue that in the recession period, there is the bounce‐back effect that contributes to the significance of the relationship; however, the authors do not further inves‐ tigate the bounce‐back effect. The empirical study of [2] finds that there is the nonlinear threshold effect in the relationship between the stock return and real economic activities. Henry et al. [9] find that when the economy is in the expansionary stage, the stock return cannot predict the output growth, while in the recession period, the stock return could well predict the output growth.

Does the recession period contain information that would impact the relationship between the stock return and economic growth? The answer can be found in **Figure 1**. 4 During a business cycle, the economy experiences peak, recession, depression, trough, and recovery and then

<sup>1</sup> None study has touched the topic whether the recession period contains other important information that can be used to examine the relationship between the stock return and economic growth.

<sup>2</sup> Most of OECD members are industrial or developed countries.

<sup>3</sup> Friedman [15] after the economy passes the bottom of the business cycle and enters a recovery period, the output will return to the original growth trend, is called the Friedman‐type asymmetry. The bounce‐back effects are one of the Friedman‐type asymmetry.

<sup>4</sup> In **Figure 1**, the CDR and new CDR (NCDR) criteria are used to divide different stages of the business cycle, which is different from the criterion listed in most textbooks.

Could the Stock Return be a Leading Indicator of the Economic Growth in the Depression? Analysis Based on... http://dx.doi.org/10.5772/63629 339

for Economic Cooperation and Development (OECD), or the Asian emerging markets (such as Singapore, Korea, the Philippines, Malaysia, Indonesia, and Taiwan) are included as sample countries as well. Research examples include in [7–11]. Most of these studies find that the relationship between the stock return and economic growth is statistically significant.

The main focus of this study is to investigate whether the relationship between the stock return and economic growth would be the same for countries with different development levels in

period is from the first quarter of 1982 to the fourth quarter of 2009, longer than that of [9].2 The new current depth of recession (NCDR) indicator proposed by Bradley and Jansen [12] is

In researches using the nonlinear model to study the relationship between the stock return and economic growth, authors often construct two regimes to divide the business cycle into two periods, the expansionary and recession periods. For example, Henry et al. [9] argue that

CDR is used as a proxy variable to examine the significance of the bounce‐back effect and to divide between the expansionary and recession periods for the nonlinear panel data model. The changes of the relationship between the stock return and output growth in the expan‐ sionary and recession periods are used to examine whether the relationship would be impacted

However, no study has touched the topic whether the recession period contains other impor‐ tant information that can be used to examine the relationship between the stock return and economic growth. Domain and Louton [2], Henry and Olekalns [13], and Henry et al. [9] find that the relationship is significantly positive only in the recession period, but the authors do not explain the reasons for this outcome. Beaudry and Koop [14], Henry and Olekalns [13], and Henry et al. [9] argue that in the recession period, there is the bounce‐back effect that contributes to the significance of the relationship; however, the authors do not further inves‐ tigate the bounce‐back effect. The empirical study of [2] finds that there is the nonlinear threshold effect in the relationship between the stock return and real economic activities. Henry et al. [9] find that when the economy is in the expansionary stage, the stock return cannot predict the output growth, while in the recession period, the stock return could well predict

Does the recession period contain information that would impact the relationship between the

cycle, the economy experiences peak, recession, depression, trough, and recovery and then

None study has touched the topic whether the recession period contains other important information that can be used

 Friedman [15] after the economy passes the bottom of the business cycle and enters a recovery period, the output will return to the original growth trend, is called the Friedman‐type asymmetry. The bounce‐back effects are one of the

In **Figure 1**, the CDR and new CDR (NCDR) criteria are used to divide different stages of the business cycle, which is

stock return and economic growth? The answer can be found in **Figure 1**.

to examine the relationship between the stock return and economic growth.

Most of OECD members are industrial or developed countries.

different from the criterion listed in most textbooks.

used here as the switched factors to capture the subperiods in the recession period.

output is characterized by asymmetry—the so‐called bounce‐back effect.3

This study employs a 26‐country sample; the sample

In that chapter, the

4

During a business

the depression and recovery subperiods.1

338 Nonlinear Systems - Design, Analysis, Estimation and Control

by the business cycle.

the output growth.

Friedman‐type asymmetry.

1

2

3

4

**Figure 1.** Business cycle process. Note: The CDR and new CDR criteria are adopted to divide the different stages of the business cycle in this figure, which is different from the criterion listed in most textbooks.

moves to another peak and completes a cycle. The recession period actually contains the depression and recovery subperiods. Depression is defined as a period that the economic situation still deteriorates and there is no sign of improvement. Recovery is defined as a period that the economy has already passed the trough; there are signs of improvement, but the economy has not returned to the original growth path. Although both the depression and recovery subperiods are within the recession period, people would have different expectations toward the future in the two different subperiods. In addition, since the stock market always reveals people's expectations of economic growth in advance, the relationship between the stock return and economic growth may differ in the two subperiods.

As to the research method on this field, previous studies often employ the time series data and the linear model; examples include in [16–19]. It is well known that the time series data structure suffers from the following two problems. First, there may not be enough observations in each subperiod, if one divides the sample period into several subperiods. Second, applying individual country data into a multicountry analysis, one may ignore the impact from the economic integration, which may cause the testing power inefficient problem. There are some problems associated with the use of the cross country data as well, for example, ignoring the impact from the time. To avoid these problems, many researches employ the panel data. This data structure has both the time and the section dimensions; therefore, the empirical result can capture the difference among sample countries and the dynamic changes from time to time. In addition, the two dimensional characteristic also increases the observation numbers, which enhances the degree of freedom.

In the present chapter, the empirical model is modified from the dynamic panel data model (DPDM) of [9]. For the DPDM, if one uses the traditional fixed effect method to estimate the model, it may lead to biased estimation results, because of the correlation between the lagged explained variables and the residual, a problem not addressed in [9]. One way to conquer this problem is to estimate the DPDM with the generalized method of moment (GMM) estimation proposed by Arellano and Bond [20].

The empirical results of this study show that in the recession periods, the stock return significantly impacts the economic growth. In addition, in some of the Asian emerging markets, the stock return is the leading indicator of the economic growth only in the recovery subperiod. As to the developed countries, the stock return is the leading indicator of the economic growth only in the depression subperiod. The empirical results have the following implications and contributions. First, for the international companies, the results can be used to avoid the misunderstandings of the recession process and the relationship between the stock return and economic growth. Second, for the investment organizations and the financial professionals, the results can help them better understand the business cycle and teach the investors the true meaning of the CDR. Third, this study contributes to the filed by further investigate the recession periods with well‐established research methods.

This chapter is organized as follows. Section 1 is the introduction. Section 2 discusses and analyzes the data. The research methodology is listed in Section 3. Section 4 shows the empirical results. Section 5 is the conclusion.
