STOCK RETURNS AND REAL ACTIVITY - A STRUCTURAL APPROACH

This paper analyzes the relationship between stock returns and real ac tivity from the point of view of a general equilibrium, multicountry m odel of the business cycle. The empirical evidence suggests that there is a relationship between domestic output growth and domestic stock r eturns which becomes stronger when foreign influences are considered. We study the properties of a model with two sources of disturbances an d three mechanisms of transmission across countries. We show that the model can best reproduce the actual data when technology shocks drive the cycle and when there is a common international component to the sh ocks. The strength of association between stock returns and output gro wth depends on how future expected cash flows respond to the disturban ces. International linkages emerge because foreign variables contain i nformation about the future path of domestic variables.