Macroeconomic sensitivity and firm level volatility: the case of New York Stock Exchange
Abstract
Purpose – This paper investigates whether the macroeconomic factors affect the firm stock returns volatility differently depending on their location in different sectors. For this purpose, daily financial time-series data for 683 firms located in nine US sectors for the period of 2000 to 2017 are employed.
Research methodology – The GARCH (1,1) model was applied to each firm located in nine US sectors. The four macroeconomic factors, namely, exchange rate, treasury yield spread, oil prices, and market return, are included in both mean and variance equations of GARCH (1,1) model to estimate the effect.
Research limitations – This research study is limited to the New York Stock Exchange; therefore, it can be extended to the other economies as well. Further, this study uses one firm feature that is the sectoral location of the firm; it is recommended that some other firm features should be studied to explore the volatility behaviour of firms. In the methodological part, this study does not include the lag effect, since it is recognised in the literature that the investors underreact to public information, so future research can be extended to test the underreaction hypothesis.
Practical implications – This study has implications for the investors and policymakers. Since it has emerged from the findings that some sectors are more sensitive than others to macroeconomic changes, so this knowledge will help the investors to diversify their portfolio and policymakers to maintain macroeconomic discipline.
Originality/Value – The main contribution of this study is that it undertakes the assumption of heterogeneous nature of firms and conducts a detailed firm level analysis by sector covering a more extended period of time to investigate the impact of four macroeconomic factors, namely, exchange rate, treasury yield spread, oil prices, and market return on firm stock returns, volatility using daily data. Further, this study contributes by including all the macroeconomic factors together as an exogenous variable in mean and conditional variance equations of the GARCH (1,1) model to investigate the effect simultaneously.
Keyword : macroeconomic sensitivity, firm volatility, heterogeneous nature of firms
How to Cite
Bashir Butt, M. S., & Mohd. Taib, H. (2021). Macroeconomic sensitivity and firm level volatility: the case of New York Stock Exchange. Business, Management and Economics Engineering, 19(2), 198-211. https://doi.org/10.3846/bmee.2021.14310
This work is licensed under a Creative Commons Attribution 4.0 International License.
References
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Bollerslev, T. (1986). Generalized autoregressive conditional heteroskedasticity. Journal of Econometrics, 31(3), 307–327. https://doi.org/10.1016/0304-4076(86)90063-1
Boni, L., & Womack, K. L. (2006). Analysts, industries, and price momentum. The Journal of Financial and Quantitative Analysis, 41(1), 85–109. https://doi.org/10.1017/S002210900000243X
Brooks, C. (2002). Introductory econometrics for finance (2nd ed.). Cambridge University Press.
Cai, W., Chen, J., Hong, J., & Jiang, F. (2015). Forecasting Chinese stock market volatility with economic variables. Emerging Markets Finance and Trade, 53(3), 521–533. https://doi.org/10.1080/1540496X.2015.1093878
Campbell, J. Y., Lettau, M., Malkiel, B. G., & Xu, Y. (2001). Have individual stocks become more volatile? An empirical exploration of idiosyncratic risk. The Journal of Finance, 56(1), 1–43. https://doi.org/10.1111/0022-1082.00318
Chen, N.-F., Roll, C.,& Ross, S. A. (1986). Economic forces and the stock market. Journal of Business, 59(3), 383–403. https://doi.org/10.1086/296344
Chen, L., Da, Z., & Zhao, X. (2013). What drives stock price movements? Review of Financial Studies, 26(4), 841–876. https://doi.org/10.1093/rfs/hht005
Cheung, Y. W., & Ng, L. K. (1992). Stock price dynamics and firm size: An empirical investigation. The Journal of Finance, 47(5), 1985–1997. https://doi.org/10.1111/j.1540-6261.1992.tb04693.x
Chinzara, Z. (2011). Macroeconomic uncertainty and conditional stock market volatility in South Africa. South African Journal of Economics, 79(1), 27–49. https://doi.org/10.1111/j.1813-6982.2011.01262.x
Chou, P.-H., Ho, P.-H., & Ko, K.-C. (2012). Do industries matter in explaining stock returns and assetpricing anomalies? Journal of Banking & Finance, 36(2), 355–370. https://doi.org/10.1016/j.jbankfin.2011.07.016
Choudhry, T., Papadimitriou, F. I., & Shabi, S. (2016). Stock market volatility and business cycle: Evidence from linear and nonlinear causality tests. Journal of Banking & Finance, 66, 89–101. https://doi.org/10.1016/j.jbankfin.2016.02.005
Christie, A. A. (1982). The stochastic behavior of common stock variances: Value, leverage and interest rate effects. Journal of Financial Economics, 10(4), 407–432. https://doi.org/10.1016/0304-405X(82)90018-6
Chun, Kim, J.-W., & Morck, R. (2009). Increased Heterogeneity among US Firms: Facts and Implications. Citeseer.
Chun, H., Kim, J., Morck, R., & Yeung, B. (2008). Creative destruction and firm-specific performance heterogeneity. Journal of Financial Economics, 89(1), 109–135. https://doi.org/10.1016/j.jfineco.2007.06.005
Comin, D., & Mulani, S. (2006). Diverging trends in aggregate and firm volatility. The Review of Economics and Statistics, 88(2), 374–383. https://doi.org/10.1162/rest.88.2.374
Corradi, V., Distaso, W., & Mele, A. (2013). Macroeconomic determinants of stock volatility and volatility premiums. Journal of Monetary Economics, 60(2), 203–220. https://doi.org/10.1016/j.jmoneco.2012.10.019
Davis, N., & Kutan, A. M. (2003). Inflation and output as predictors of stock returns and volatility: international evidence. Applied Financial Economics, 13(9), 693–700. https://doi.org/10.1080/09603100210139429
Davis, S. J., & Kahn, J. A. (2008). Interpreting the great moderation: Changes in the volatility of economic activity at the macro and micro levels. National Bureau of Economic Research. https://doi.org/10.3386/w14048
Dornbusch, R., & Fischer, S. (1980). Exchange rates and the current account. The American Economic Review, 70(5), 960–971.
Elyasiani, E., & Mansur, I. (2003). International spillover of risk and return among major banking institutions: A bivariate GARCH model. Journal of Accounting, Auditing & Finance, 18(2), 303–330. https://doi.org/10.1177/0148558X0301800207
Elyasiani, E., Mansur, I., & Odusami, B. (2011). Oil price shocks and industry stock returns. Energy Economics, 33(5), 966–974. https://doi.org/10.1016/j.eneco.2011.03.013
Engle, R. F. (1982). Autoregressive conditional heteroscedasticity with estimates of the variance of United Kingdom inflation. Econometrica: Journal of the Econometric Society, 50(4), 987–1007. https://doi.org/10.2307/1912773
Engle, R. F., Ghysels, E., & Sohn, B. (2013). Stock market volatility and macroeconomic fundamentals. Review of Economics and Statistics, 95(3), 776–797. https://doi.org/10.1162/REST_a_00300
Ewing, B., Kruse, J., & Thompson, M. (2005). Comparing the impact of news: a tale of three health care sectors. Journal of Business Finance and Accounting, 32(7–8), 1587–1611. https://doi.org/10.1111/j.0306-686X.2005.00641.x
Khan, F., Khan, S. U. R., & Khan, H. (2016). Pricing of risk, various volatility dynamics and macroeconomic exposure of firm returns: new evidence on age effect. International Journal of Economics and Financial Issues, 6(2), 551–561.
Kumar, M. (2013). Returns and volatility spillover between stock prices and exchange rates. International Journal of Emerging Markets, 8(2), 108–128. https://doi.org/10.1108/17468801311306984
Li, M. C. (2014). The US zero-coupon yield spread as a predictor of excess daily stock market volatility. Applied Financial Economics, 24(13), 889–906. https://doi.org/10.1080/09603107.2014.914141
Ljung, G. M., & Box, G. E. (1978). On a measure of lack of fit in time series models. Biometrika, 65(2), 297–303. https://doi.org/10.1093/biomet/65.2.297
Mandimika, N. Z., & Chinzara, Z. (2012). Risk–return trade‐off and behaviour of volatilitt on the South African stock market: Evidence from both aggregate and disaggregate data. South African Journal of Economics, 80(3), 345–366. https://doi.org/10.1111/j.1813-6982.2012.01328.x
Mankiw, N. G., Romer, D., & Shapiro, M. D. (1985). An unbiased reexamination of stock market volatility. The Journal of Finance, 40(3), 677–687. https://doi.org/10.1111/j.1540-6261.1985.tb04990.x
Melitz, M. J., & Redding, S. J. (2012). Heterogeneous firms and trade. National Bureau of Economic Research. https://doi.org/10.3386/w18652
Mwang, M., & Mwit, J. K. (2015). The effect of voluntary disclosure on stock market returns of companies listed at the Nairobi securities exchange. International Journal of Business and Social Science, 6(1), 99–105.
Narayan, P. K., & Sharma, S. S. (2011). New evidence on oil price and firm returns. Journal of Banking & Finance, 35(12), 3253–3262. https://doi.org/10.1016/j.jbankfin.2011.05.010
Narayan, P. K., & Sharma, S. S. (2014). Firm return volatility and economic gains: The role of oil prices. Economic Modelling, 38, 142–151. https://doi.org/10.1016/j.econmod.2013.12.004
Nathan, L. J., & Panayiotis, V. (2006). The sensitivity of US banks’ stock returns to interest rate and exchange rate changes. Managerial Finance, 32(2), 182–199. https://doi.org/10.1108/0307435061064193
Organization for Economic Cooperation and Development. (2016). Organization for Economic Cooperation and Developement Economic Surveys: United States.
Schwert, G. W. (1989). Why does stock market volatility change over time? The Journal of Finance, 44(5), 1115–1153. https://doi.org/10.1111/j.1540-6261.1989.tb02647.x
Sharma, P., & Vipul. (2015). Forecasting stock index volatility with GARCH models: international evidence. Studies in Economics and Finance, 32(4), 445–463. https://doi.org/10.1108/SEF-11-2014-0212
Sharma, S. S., & Narayan, P. K. (2014). New evidence on turn-of-the-month effects. Journal of International Financial Markets, Institutions and Money, 29, 92–108. https://doi.org/10.1016/j.intfin.2013.12.002
Sharma, S. S., Narayan, P. K., & Zheng, X. (2014). An analysis of firm and market volatility. Economic Systems, 38(2), 205–220. https://doi.org/10.1016/j.ecosys.2013.12.003
Shiller, R. J. (1980). Do stock prices move too much to be justified by subsequent changes in dividends? National Bureau of Economic Research Cambridge, Mass., USA. https://doi.org/10.3386/w0456
Shiller, R. J. (1981). The use of volatility measures in assessing market efficiency. The Journal of Finance, 36(2), 291–304. https://doi.org/10.1111/j.1540-6261.1981.tb00441.x
Tsai, C.-L. (2015). How do U.S. stock returns respond differently to oil price shocks pre-crisis, within the financial crisis, and post-crisis? Energy Economics, 50, 47–62. https://doi.org/10.1016/j.eneco.2015.04.012
Xu, Y., & Malkiel, B. G. (2003). Investigating the behavior of idiosyncratic volatility. The Journal of Business, 76(4), 613–645. https://doi.org/10.1086/377033
Yeaple, S. R. (2005). A simple model of firm heterogeneity, international trade, and wages. Journal of International Economics, 65(1), 1–20. https://doi.org/10.1016/j.jinteco.2004.01.001
Zakoian, J.-M. (1994). Threshold heteroskedastic models. Journal of Economic Dynamics and Control, 18(5), 931–955. https://doi.org/10.1016/0165-1889(94)90039-6
Agrawal, G. (2010). A study of exchange rates movement and stock market volatility. International Journal of Business and Management, 5(12). https://doi.org/10.5539/ijbm.v5n12p62
Beltratti, & Morana, C. (2006). Breaks and persistency: macroeconomic causes of stock market volatility. Journal of Econometrics, 131(1–2), 151–177. https://doi.org/10.1016/j.jeconom.2005.01.007
Bernard, A. B., Jensen, J. B., & Lawrence, R. Z. (1995). Exporters, jobs, and wages in US manufacturing: 1976–1987. In Brookings papers on economic activity. Microeconomics (pp. 67–119). https://doi.org/10.2307/2534772
Black, F. (1976). Stock market volatility changes. In Proceedings of the American Statistical Association, Business and Economics Section (pp. 177–181).
Bollerslev, T. (1986). Generalized autoregressive conditional heteroskedasticity. Journal of Econometrics, 31(3), 307–327. https://doi.org/10.1016/0304-4076(86)90063-1
Boni, L., & Womack, K. L. (2006). Analysts, industries, and price momentum. The Journal of Financial and Quantitative Analysis, 41(1), 85–109. https://doi.org/10.1017/S002210900000243X
Brooks, C. (2002). Introductory econometrics for finance (2nd ed.). Cambridge University Press.
Cai, W., Chen, J., Hong, J., & Jiang, F. (2015). Forecasting Chinese stock market volatility with economic variables. Emerging Markets Finance and Trade, 53(3), 521–533. https://doi.org/10.1080/1540496X.2015.1093878
Campbell, J. Y., Lettau, M., Malkiel, B. G., & Xu, Y. (2001). Have individual stocks become more volatile? An empirical exploration of idiosyncratic risk. The Journal of Finance, 56(1), 1–43. https://doi.org/10.1111/0022-1082.00318
Chen, N.-F., Roll, C.,& Ross, S. A. (1986). Economic forces and the stock market. Journal of Business, 59(3), 383–403. https://doi.org/10.1086/296344
Chen, L., Da, Z., & Zhao, X. (2013). What drives stock price movements? Review of Financial Studies, 26(4), 841–876. https://doi.org/10.1093/rfs/hht005
Cheung, Y. W., & Ng, L. K. (1992). Stock price dynamics and firm size: An empirical investigation. The Journal of Finance, 47(5), 1985–1997. https://doi.org/10.1111/j.1540-6261.1992.tb04693.x
Chinzara, Z. (2011). Macroeconomic uncertainty and conditional stock market volatility in South Africa. South African Journal of Economics, 79(1), 27–49. https://doi.org/10.1111/j.1813-6982.2011.01262.x
Chou, P.-H., Ho, P.-H., & Ko, K.-C. (2012). Do industries matter in explaining stock returns and assetpricing anomalies? Journal of Banking & Finance, 36(2), 355–370. https://doi.org/10.1016/j.jbankfin.2011.07.016
Choudhry, T., Papadimitriou, F. I., & Shabi, S. (2016). Stock market volatility and business cycle: Evidence from linear and nonlinear causality tests. Journal of Banking & Finance, 66, 89–101. https://doi.org/10.1016/j.jbankfin.2016.02.005
Christie, A. A. (1982). The stochastic behavior of common stock variances: Value, leverage and interest rate effects. Journal of Financial Economics, 10(4), 407–432. https://doi.org/10.1016/0304-405X(82)90018-6
Chun, Kim, J.-W., & Morck, R. (2009). Increased Heterogeneity among US Firms: Facts and Implications. Citeseer.
Chun, H., Kim, J., Morck, R., & Yeung, B. (2008). Creative destruction and firm-specific performance heterogeneity. Journal of Financial Economics, 89(1), 109–135. https://doi.org/10.1016/j.jfineco.2007.06.005
Comin, D., & Mulani, S. (2006). Diverging trends in aggregate and firm volatility. The Review of Economics and Statistics, 88(2), 374–383. https://doi.org/10.1162/rest.88.2.374
Corradi, V., Distaso, W., & Mele, A. (2013). Macroeconomic determinants of stock volatility and volatility premiums. Journal of Monetary Economics, 60(2), 203–220. https://doi.org/10.1016/j.jmoneco.2012.10.019
Davis, N., & Kutan, A. M. (2003). Inflation and output as predictors of stock returns and volatility: international evidence. Applied Financial Economics, 13(9), 693–700. https://doi.org/10.1080/09603100210139429
Davis, S. J., & Kahn, J. A. (2008). Interpreting the great moderation: Changes in the volatility of economic activity at the macro and micro levels. National Bureau of Economic Research. https://doi.org/10.3386/w14048
Dornbusch, R., & Fischer, S. (1980). Exchange rates and the current account. The American Economic Review, 70(5), 960–971.
Elyasiani, E., & Mansur, I. (2003). International spillover of risk and return among major banking institutions: A bivariate GARCH model. Journal of Accounting, Auditing & Finance, 18(2), 303–330. https://doi.org/10.1177/0148558X0301800207
Elyasiani, E., Mansur, I., & Odusami, B. (2011). Oil price shocks and industry stock returns. Energy Economics, 33(5), 966–974. https://doi.org/10.1016/j.eneco.2011.03.013
Engle, R. F. (1982). Autoregressive conditional heteroscedasticity with estimates of the variance of United Kingdom inflation. Econometrica: Journal of the Econometric Society, 50(4), 987–1007. https://doi.org/10.2307/1912773
Engle, R. F., Ghysels, E., & Sohn, B. (2013). Stock market volatility and macroeconomic fundamentals. Review of Economics and Statistics, 95(3), 776–797. https://doi.org/10.1162/REST_a_00300
Ewing, B., Kruse, J., & Thompson, M. (2005). Comparing the impact of news: a tale of three health care sectors. Journal of Business Finance and Accounting, 32(7–8), 1587–1611. https://doi.org/10.1111/j.0306-686X.2005.00641.x
Khan, F., Khan, S. U. R., & Khan, H. (2016). Pricing of risk, various volatility dynamics and macroeconomic exposure of firm returns: new evidence on age effect. International Journal of Economics and Financial Issues, 6(2), 551–561.
Kumar, M. (2013). Returns and volatility spillover between stock prices and exchange rates. International Journal of Emerging Markets, 8(2), 108–128. https://doi.org/10.1108/17468801311306984
Li, M. C. (2014). The US zero-coupon yield spread as a predictor of excess daily stock market volatility. Applied Financial Economics, 24(13), 889–906. https://doi.org/10.1080/09603107.2014.914141
Ljung, G. M., & Box, G. E. (1978). On a measure of lack of fit in time series models. Biometrika, 65(2), 297–303. https://doi.org/10.1093/biomet/65.2.297
Mandimika, N. Z., & Chinzara, Z. (2012). Risk–return trade‐off and behaviour of volatilitt on the South African stock market: Evidence from both aggregate and disaggregate data. South African Journal of Economics, 80(3), 345–366. https://doi.org/10.1111/j.1813-6982.2012.01328.x
Mankiw, N. G., Romer, D., & Shapiro, M. D. (1985). An unbiased reexamination of stock market volatility. The Journal of Finance, 40(3), 677–687. https://doi.org/10.1111/j.1540-6261.1985.tb04990.x
Melitz, M. J., & Redding, S. J. (2012). Heterogeneous firms and trade. National Bureau of Economic Research. https://doi.org/10.3386/w18652
Mwang, M., & Mwit, J. K. (2015). The effect of voluntary disclosure on stock market returns of companies listed at the Nairobi securities exchange. International Journal of Business and Social Science, 6(1), 99–105.
Narayan, P. K., & Sharma, S. S. (2011). New evidence on oil price and firm returns. Journal of Banking & Finance, 35(12), 3253–3262. https://doi.org/10.1016/j.jbankfin.2011.05.010
Narayan, P. K., & Sharma, S. S. (2014). Firm return volatility and economic gains: The role of oil prices. Economic Modelling, 38, 142–151. https://doi.org/10.1016/j.econmod.2013.12.004
Nathan, L. J., & Panayiotis, V. (2006). The sensitivity of US banks’ stock returns to interest rate and exchange rate changes. Managerial Finance, 32(2), 182–199. https://doi.org/10.1108/0307435061064193
Organization for Economic Cooperation and Development. (2016). Organization for Economic Cooperation and Developement Economic Surveys: United States.
Schwert, G. W. (1989). Why does stock market volatility change over time? The Journal of Finance, 44(5), 1115–1153. https://doi.org/10.1111/j.1540-6261.1989.tb02647.x
Sharma, P., & Vipul. (2015). Forecasting stock index volatility with GARCH models: international evidence. Studies in Economics and Finance, 32(4), 445–463. https://doi.org/10.1108/SEF-11-2014-0212
Sharma, S. S., & Narayan, P. K. (2014). New evidence on turn-of-the-month effects. Journal of International Financial Markets, Institutions and Money, 29, 92–108. https://doi.org/10.1016/j.intfin.2013.12.002
Sharma, S. S., Narayan, P. K., & Zheng, X. (2014). An analysis of firm and market volatility. Economic Systems, 38(2), 205–220. https://doi.org/10.1016/j.ecosys.2013.12.003
Shiller, R. J. (1980). Do stock prices move too much to be justified by subsequent changes in dividends? National Bureau of Economic Research Cambridge, Mass., USA. https://doi.org/10.3386/w0456
Shiller, R. J. (1981). The use of volatility measures in assessing market efficiency. The Journal of Finance, 36(2), 291–304. https://doi.org/10.1111/j.1540-6261.1981.tb00441.x
Tsai, C.-L. (2015). How do U.S. stock returns respond differently to oil price shocks pre-crisis, within the financial crisis, and post-crisis? Energy Economics, 50, 47–62. https://doi.org/10.1016/j.eneco.2015.04.012
Xu, Y., & Malkiel, B. G. (2003). Investigating the behavior of idiosyncratic volatility. The Journal of Business, 76(4), 613–645. https://doi.org/10.1086/377033
Yeaple, S. R. (2005). A simple model of firm heterogeneity, international trade, and wages. Journal of International Economics, 65(1), 1–20. https://doi.org/10.1016/j.jinteco.2004.01.001
Zakoian, J.-M. (1994). Threshold heteroskedastic models. Journal of Economic Dynamics and Control, 18(5), 931–955. https://doi.org/10.1016/0165-1889(94)90039-6