Output and Expected Returns: A Multicountry Study

Abstract

This paper analyzes whether the price-output ratio (the py-ratio) predicts returns in 12 OECD countries. The py-ratio is a ratio of a share price to a macroeconomic variable. Traditionally, either ratios of purely financial indicators, ratios of purely macroeconomic indicators, or ratios of macroeconomic indicators to wealth have been used to predict returns. However, if share prices are mean reverting, and thus contain a predictable component, and predictability of returns is related to the macroeconomic environment that ultimately determines the investment opportunities, a ratio of a share price to a macroeconomic variable could be believed to predict returns. The analyses reveal that the py-ratios do indeed predict future stock returns in most of the countries that are studied.

Note: Previously titled Output and Expected Returns

Keywords: share prices, output of firms, return predictability

JEL Classification: F30, G15