A Common-Use Proxy for Economic Performance: Application to Asymmetric Causality between the Stock Returns and Growth

Abstract

This study develops a common-use proxy based on the so-called “current depth of recession” (CDR) measure of economic performance. The proposed proxy, termed MCDR, removes the limitations of the nonlinear model from the CDR. The MCDR enjoys the benefits of the CDR but also extends directly to threshold variables, becoming a useful_x000D_ covariate in general threshold models. Considering the correlation between annual stock_x000D_ returns and economic growth rates in 25 countries during the last 44 years, we employ the MCDR as a threshold variable in a threshold vector autoregressive model. The empirical results show that stock returns mostly lead economic growth rates during recessions but are unable to effectively predict growth rates during expansions. We find that the MCDR represents a useful construction, enlarging the scope of practical CDR applications.