Fiscal Policy and the US Stock Market

Posted: 21 Apr 2018

See all articles by Cedric Mbanga

Cedric Mbanga

Missouri State University

Ali F. Darrat

Louisiana Tech University - College of Business

Date Written: Decmber 1, 2016

Abstract

This paper empirically explores the short- and long-run effects of fiscal and monetary policies on US stock returns and tests the validity of market efficiency. The results support the presence of a strong long-run (equilibrium) relation binding stock prices with fiscal (but not monetary) policy. Further tests assign a dominant role to fiscal policy as a main force driving the overall equilibrium relation with the stock market. Estimates from error-correction models corroborate the existence of robust long-run relation and further suggest that past fiscal (but not monetary) policy actions exert significant short-run effects on current stock returns. A similar verdict emerged from alternative estimates in which fiscal policy actions anticipated from an ex ante equation continue to support a significant lagged relation with current stock returns. These results provide consistent evidence that important effects of fiscal policy are transmitted to the real economy through the stock market. Moreover, the results for fiscal policy appear at variance with market efficiency. However, transaction costs and other well-known modeling caveats may impede implications for profitable investment strategies.

Keywords: Error Correction, Market Efficiency, Fiscal and Monetary Policies

JEL Classification: E44, G14

Suggested Citation

Mbanga, Cedric and Darrat, Ali F., Fiscal Policy and the US Stock Market (Decmber 1, 2016). Review of Quantitative Finance and Accounting, Vol. 47, No. 4, 2016, Available at SSRN: https://ssrn.com/abstract=3156785

Cedric Mbanga (Contact Author)

Missouri State University ( email )

Glass 312
Springfield, MO 65807
United States

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

Ali F. Darrat

Louisiana Tech University - College of Business ( email )

Department of Economics & Finance
P.O. Box 10318
Ruston, LA 71272
United States
318-257-3874 (Phone)
318-257-4253 (Fax)

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