Causal relations among different sizes of stock returns, interest rates, real activity, and inflation

This paper investigates the causal relations and dynamic interactions among the different sizes of stock returns, interest rates, real activity, and inflation. The generalized impulse response functions and the generalized forecast error variance decomposition are computed in order to investigate interrelationships within the system. Results reveal that Unrestricted Vector Auto Regression outcome is a function of the size of stock returns. Specifically, the results suggest that the stock returns for the fifth and tenth deciles are leading indicators for future macroeconomic performance. However, stock return for the first decile leads the inflation rate and real interest rate but does not lead the real economic activity as represented by industrial production. © 2010, Banking and Finance Review.