ABSTRACT Title The Effect of Macroeconomic Variables on Market Premium. Study of Sweden, Germany and Canada Authors Samira Allahyari Westlund Arad Tahmidi Dmytro Sheludchenko Supervisor Christos Papahristodoulou Key words Macroeconomic, market risk premium, GDP, inflation, money supply, primary net lending and net borrowing, regression analysis. Institution Mälardalen University School of Sustainable Development of Society and Technology Box 883, SE-721 23 Västerås Sweden Course Bachelor Thesis in Economics (NAA 301), 15 ECTS Problem statement Risk premium value is of great interest to the financial world, since this value represents the extra return that investors receive considering the risk from investing in financial markets. The fluctuations in stock markets are believed to be influenced by changes in macroeconomic variables. Purpose The purpose of this paper is to analyze the effect of macroeconomic variables on and their relation to market risk premium in Canada, Sweden and Germany in the years 1992 – 2007. Method Multiple Regression Analysis, Ordinary Least squares (OLS) Result Forecasted Growth in real GDP is the only macroeconomic variable which has significant relation with market risk premium. The effect of money supply was found to be insignificant. Net lending and net borrowing had significant negative effect on market risk premium in Canada, whereas in Germany and Sweden the relationship was not significant.

One of the most important objectives for any countries is to sustain high economic growth. Even though there are main factors that affect economic growth, the concern of this paper is only about inflation. The relationship between economic growth and inflation is debatable. The first objective of this study is to investigate the relationship between inflation and economic growth. This study uses panel data which includes 13 SSA countries from 1969 to 2009. To analyze the data the model is formed by taking economic growth as dependent variable and four variables (i.e. inflation, investment, population and initial GDP) as independent variables. The result indicates that there is a negative relationship between economic growth and inflation. This study is also examined the causality relationship between economic growth and inflation by using panel Granger causality test. Panel granger causality test shows that inflation can be used in order to predict growth for all countries in the sample, while the opposite it is only true for Congo, Dep. Rep and Zimbabwe.

During inflation quantum fluctuations of the field driving inflation, known as inflaton, were stretched by inflationary expansion to galactic size scales or even larger. A possible implication of inflation -- if it is correct -- is that our observable universe was once of sub-Planckian size. Thus inflation could act as a magnifier to probe the short distance structure of space-time. General arguments about the quantum theory of gravity suggest that the short distance structure of space-time can be modeled as arising from some corrections to the well-known uncertainty relation between the position and momentum operators. Such modifications have been predicted by more fundamental theories such as string theory. This modified commutation relation has been implemented at the first quantized level to the theory of cosmological perturbations. In this thesis, we will show that the aforementioned scenario of implementing the minimal length to the action has an ambiguity: total time derivatives that in continuous space-time could be neglected and do not contribute to the equations of motion, cease to remain total time derivatives as we implement minimal length. Such an ambiguity opens up the possibility for trans-Planckian physics to leave an imprint on the ratio of tensor to scalar fluctuations. In near de-Sitter space, we obtain the explicit dependence of the tensor/scalar on the minimal length. Also the first consistency relation is examined in a power-law background, where it is found that despite the ambiguity that exists in choosing the action, Planck scale physics modifies the consistency relation considerably as it leads to large oscillations in the scalar spectral index in the observable range of scales. In the second part of the thesis, I demonstrate how the assumption of existence of invariant minimal length can assist us to explain the origin of cosmic magnetic fields. The third part of the thesis is dedicated to the study of signatures of M-theory Cascade inflation.

This dissertation includes two chapters in the field of international finances about foreign exchange rate predictability and testing purchase power parity. In each chapter, we build the theory, methodology, and the empirical results to present the paper¡¦s construction. The first chapter, we studies whether the pure price inflation rate which is extracted from stock return can help us to test the relative of purchasing power parity in where Asian countries include Malaysia, Korea, Taiwan, Thailand, Hong Kong, and Singapore against the United States. The paper of Chowdhry et al. (2005) argue that relative PPP may not hold for the official price inflation rates which is constructed from consumer price indices, since relative price changes and other frictions cause price to be sticky. Thus, they use the Fisher equation and Fama-French three factors elaborately to build up a model on the nominal return of real risk-free asset to extract the pure price inflation rates. Their argument is supported in the case of Japan, Germany, the United States, and the United Kingdom. We are interested in the case of some Asian countries. So, this chapter, we extend the model and methodology of Chowdhry et al. (2005) to test the relative PPP for Asian countries. If our empirical evidence is firmly supported, it will be a strongly reconfirmed the elaborated idea of Chowdhry et al. (2005). In our study, the PPP rule is not supported for Asian countries since joint null hypothesis of a=0 and b=1 are rejected at all horizons except Taiwan at monthly horizon. The testing results by constrained seeming unrelated regression (SUR) and system equation in pooled data are similar to the tests of country-by-country. Therefore, we apply the methods of panel unite root from Im et al. (2003), Maddala and Wu (1999), and Pesaran (2007) to test the PPP doctrine, and it is strongly supported PPP for Asian countries. The second chapter, we extract the estimated data of pure price inflation by Chowdhry et al. (2005), and use the data to build up a nonlinear STR (smooth transition autoregressive) model by Granger and Teräsvirta (1993), then compare the performance of linear or nonlinear model of exchange rate predictability with random walk model in the United States, the United Kingdom, Japan, and Germany. This study has presented evidences that the extracted inflation rates offer a good predictability on the prediction of exchange rate for the United Kingdom and Germany. Those extracted data in which are calculated from the industry portfolio returns of stock market. The issue of series correlation in regression error does matter the estimated coefficients £]k, thus we estimate the simulation of Gaussian bootstrap distribution for testing variables with Newey West standard deviation in regression estimate. The empirical evidences show that the PPP doctrine affects the predictability performance of exchange rate change by the extracted inflation rates.

This paper contains two parts. First, we study the decoy effect (especially for the compromise decoy effect) by the experiments where the subjects face the trade-off of inflation and unemployment. As earlier studies show that the compromise decoy is not good as dominated decoy, we try to explore factors of determining compromise effect. Second, we investigate the factors affecting the subjects¡¦ preference over unemployment and inflation. In Part 1, we explore how to enhance the compromise decoy effect by changing the relative location among target, compromise, and decoy. It emerges that the distance between target and decoy, the distance between target and competitor, and the existence of the dominated decoy all affect the size of the compromise decoy effect. In Part 2, we explore the relation of subjects¡¦ preference over inflation and unemployment and their personal characteristics, such as location of hometown, the attitude toward risk, political participation, ideology, household income, knowledge of related terminology, whether to take related course or not, and friends¡¦ and relatives¡¦ unemployment status, and so on. Though the direction of effects is in line with our conjecture, the level of significance is not high enough.

As the price level soars up, it become more important to study the dynamic relation between stock prices, price indices. In this paper we suspect that property stocks serve as tools of anti-inflation and examine whether there exists a positive correlation between the prices of property stocks and price indices, such as the Rent Index, CPI, and WPI. Our results confirm the positive correlation between the prices of property stocks and the price indices. More precisely, it is revealed by applying VAR and the impulse response analysis that the positive correlation between the prices of property stocks and CPI/WPI in the short run. Using the cointegration analysis, we detect the long-run relation between the prices of property stocks and the Rent Index.

This dissertation contains three applications of time series in finance and macroeconomics. The first essay compares the cumulative returns for stocks and bonds at investment horizons from one to ten years by using a test for spatial dominance. Spatial dominance is a variation of stochastic dominance for nonstationary variables. The results suggest that for investment horizons of one year, bonds spatially dominate stocks. In contrast, for investment horizons longer than five years, stocks spatially dominate bonds. This result is consistent with the advice given by practitioners to long term investors of allocating a higher proportion of stocks in their portfolio decisions. The second essay presents a method that allows testing of whether or not an asset stochastically dominates the other when the time horizon is uncertain. In this setup, the expected utility depends on the distribution of the value of the asset as well as the distribution of the time horizon, which together form the weighted spatial distribution. The testing procedure is based on the Kolmogorov Smirnov distance between the empirical weighted spatial distributions. An empirical application is presented assuming that the event of exit time follows an independent Poisson process with constant intensity. The last essay applies a dynamic factor model to generate out-of-sample forecasts for the inflation rate in Mexico. Factor models are useful to summarize the information contained in large datasets. We evaluate the role of using a wide range of macroeconomic variables to forecast inflation, with particular interest on the importance of using the consumer price index disaggregated data. The data set contains 54 macroeconomic series and 243 consumer price subcomponents from 1988 to 2008. The results indicate that factor models outperform the benchmark autoregressive model at horizons of one, two, four and six quarters. It is also found that using disaggregated price data improves forecasting performance.

Protection against inflation is an essential part of the today&#039 / s financial markets, particularly in high-inflation economies. Hence, nowadays inflation indexed instruments are being increasingly popular in the world financial markets. In this thesis, we focus on pricing of the inflation-indexed bonds which are the unique inflation-indexed instruments traded in the Turkish bond market. Firstly, we review the Jarrow-Yildirim model which deals with pricing of the inflation-indexed instruments within the HJM framework. Then, we propose a pricing model that is an extension of the Jarrow-Yildirim model. The model allows instantaneous forward rates, inflation index and bond prices to be driven by both a standard Brownian motion and a finite number of Poisson processes. A closed-form pricing formula for an European call option on the inflation index is also derived.

This study investigates the determinants of financial development and private sector credits for a panel of 85 developing and industrial countries using annual data from 1980 to 2006. The results from the panel cross-sectional fixed effects procedure suggest that an increase in the public sector credits and central government debt leads to a decrease in private sector credits in low income and lower middle income counties. For this group of countries, public sector credits, albeit leading to a financial crowding out, are found to be enhancing financial development. For the upper middle income and high income countries, private sector credits are found to increase with public sector credits and financial development and decrease with central government debt. Financial development is affected adversely from inflation and positively from real GDP and public sector credits in high income countries. In upper middle income countries both real GDP and credits to public sector affect financial development positively. In low income countries, on the other hand, public sector credits and inflation are correlated positively with financial development.

This thesis analyses the information content of inflation adjusted financial statements for investors and the informational value of accounting earnings and systematic risk in explaining stock returns in Turkey. Information content of inflation accounting is tested by using event study methodology. Results show that, contrary to 2002, there exist abnormal returns/(losses) in the period surrounding the announcement of 2004 financial statements. However, due to non-company specific political and economic conditions around the announcement days, we cannot precisely state that either the inflation adjustment or the political forces cause the abnormal price activity at the time of research. Second part of the thesis is based on the regression study methodology which shows the significance of accounting earnings and firms&rsquo / systematic risk in explaining stock returns, in different economic conjectures. Results show that earnings have informational value for 2003 and 2004 fiscal years while systematic risk is significant in the period before 2003. This may imply that earnings become significant in good periods of the economy while the systematic risk becomes significant when the economy is in recession or recovery periods.