As the stock market is the barometer of the health of the economy and reflects the expectations of investors, it is recognized that the stock market return has a predictive power of future GDP growth. In this paper, we examine the relation between GDP growth and stock market return within a country panel framework and analyze whether the following variables can improve the predictability of the market on future growth: 1. Rule of Law; 2. Government Effectiveness; 3. Market Capitalization; 4. Trade Openness. The analysis is done using a panel of 89 countries over the period 1989 to 2018 (30 years), which is a period of both rapid global development as well as that of the global financial crisis. Our study indicates that political variables such as increased rule of law and greater government effectiveness increase the market return’s predictability of GDP growth. We logically conclude that the GDP growth of developed countries is better predicted by market return because developed countries' growth is less affected by government idiosyncratic intervention and corruption and are more affected by the information economy and world growth factors.
MSc in Finance Project-Simon Fraser University
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