US stock market sensitivity to interest and inflation rates: a quantile regression approach

ABSTRACT

This article studies the sensitivity of the US stock market to nominal and real interest rates and inflation during the 2003–2013 period using quantile regression (QR). The empirical results show that the stock market has a significant sensitivity to changes in interest rates and inflation and finds differences across sectors and over time. Moreover, the effect of changes in both interest rates and inflation tends to be more pronounced during extreme market conditions, thus distinguishing expansion periods from recession periods.

KEYWORDS:

• Interest rate risk
• stock returns
• interest and inflation rates
• industries
• quantile regression

JEL CLASSIFICATION:

• G12
• C21
• G32

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ This methodology is gaining increasing popularity as an alternative to OLS estimation because of its greater flexibility and robustness.

² The S&P 500 index was created by the financial services company Standard & Poor’s. This index includes the 500 largest companies in the United States. This index weights each company by market capitalization (data extracted from: http://www.investing.com/).

³ Monthly frequency is preferred to daily or weekly regularity because daily volatility is higher than weekly volatility; in turn, weekly volatility is higher than monthly volatility.

⁴ Components of the S&P 500 updated through 7 April 2014.

⁵ These historical data of long-term interest rates are extracted from: www.investing.com/

⁶ These data are extracted from: http://ec.europa.eu/eurostat/data/database

⁷ As shown, the nominal interest rate is a I(1) series; therefore, this variable is not included in levels, but in first differences. Therefore, its components (real interest and expected inflation rates) are also considered in first differences (Jareño 2008).

⁸ Refer to Buchinsky (1998) for further details on QR.

⁹ Refer to http://www.nber.org/cycles.html

¹⁰ Additionally, we applied the Bootstrap method, which consists of generating replicas of the standard errors for the QR coefficients; however, the results obtained were not sufficiently significant to incorporate them into this work.

¹¹ According to Jareño and Navarro (2010), there is evidence of a relevant relation between the impact of nominal interest rate changes on stock returns and the ability of these companies to transmit inflation shocks to the prices of their products/services.

¹² Please refer to http://www.nber.org/cycles.html

¹³ The fact that these two variables show similar results could indicate the need to orthogonalize the explanatory variables included in model 2. Therefore, a possible extension of the work may be to use an orthogonalization technique to remove any relation that exists between explanatory factors.

Additional information

Funding

This research was funded by a grant from the ‘ Ramón Areces Foundation public call to bid, 2013’, entitled Interest and inflation risk: study of the American stock market.