Using Stock Returns to Identify Government Spending Shocks: New Insights

50 Pages Posted: 9 Mar 2022

See all articles by Ruchith Dissanayake

Ruchith Dissanayake

Queensland University of Technology - School of Economics and Finance

Date Written: January 11, 2022

Abstract

The existing instruments of government spending using accumulated stock returns of military contractors generate vastly different consumption and investment impulse responses when compared to the narratively identified war news shocks as per Ramey (2011). We show that a reason for this difference is because of the persistence in the accumulated stock returns. Instead, a return spread between diversified portfolios of defense firms minus private consumption and investment-good firms (DMP) renders persistence and generates responses akin to war news shocks. DMP return spread is a relevant instrument for post-1963 period and the spread Granger-causes shocks identified using standard VAR approach.

Keywords: Government spending shocks, DMP returns, stock return identification

JEL Classification: E62, N42

Suggested Citation

Dissanayake, Ruchith, Using Stock Returns to Identify Government Spending Shocks: New Insights (January 11, 2022). Available at SSRN: https://ssrn.com/abstract=4006335 or http://dx.doi.org/10.2139/ssrn.4006335

Ruchith Dissanayake (Contact Author)

Queensland University of Technology - School of Economics and Finance ( email )

GPO Box 2434
2 George Street
Brisbane, Queensland 4001
Australia

HOME PAGE: http://www.rdissanayake.com

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