Leading indicator information in UK equity prices: an assessment of economic tracking portfolios

Working papers set out research in progress by our staff, with the aim of encouraging comments and debate.
Published on 12 June 2001

Working Paper no. 137
By Simon Hayes

An economic tracking portfolio (ETP) is a portfolio of financial assets whose returns are correlated with some macroeconomic variable of interest. Specifically, an ETP is designed to track revisions to investors’ expectations about the target macroeconomic variable. My primary interest is in whether ETPs are a useful tool for conjunctural economic assessment, providing information about expectations of future macroeconomic outcomes. I estimate a set of ETPs using UK equity returns for three target variables: inflation, industrial production growth, and growth in the volume of retail sales. In sample, it is possible to track all three target variables with equity returns. But the out-of-sample results are poor. Although some ETPs retain significant explanatory power, most do not, and in all cases there is a substantial deterioration in the relationship between the ETPs and the target variables. Covariances between equity returns and macroeconomic variables appear to change substantially over time, and the consequent instability in portfolio weights significantly diminishes the usefulness of ETPs for conjunctural analysis.

PDFLeading indicator information in UK equity prices: an assessment of economic tracking portfolios 

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