Exploring the Relationship between Coincident Financial Market Indicators

Conclusion

Following Chauvet and Potter (2000), we represented the monthly stock market fluctuations by constructing a non-linear coincident financial indicator in this chapter. The indicator is constructed as an unobservable factor whose first moment and conditional volatility are driven by a two-state Markov variable. The model is applied to economic data from Japan, the UK, and the USA, and successfully estimated for each of these industrialized countries. The coincident indicator has a particularly high correlation with excess returns, and its time series path is remarkably similar to the excess return series in Japan, the UK, and the USA. The estimated indicator can be interpreted as the investor’s real-time belief about the state of financial conditions. In other words, it can be viewed as a coincident indicator of movements in the stock market reflecting common assessments of the implications of given sets of financial information.