A Dynamic Heterogeneous Panel Estimation of the Impact of Income, Inflation and Happiness on Stock Returns

Ratneswary Rasiah, Muzafar Shah Habibullah and Baharom Abdul Hamid

This study examines the long-run relationships and short-run dynamic interactions between stock returns and its determinants comprising of GDP per capita, inflation and happiness, over the period 1973 to 2012. The study applies the dynamic heterogenous panel estimation techniques of Mean Group (MG), Pooled Mean Group (PMG) and Dynamic Fixed Effects (DFE) to analyse a set of macro panel data on selected OECD countries to establish the possible causal relations between these variables. The theoretical framework of this study is based on the stock returns theories of Present Value Model/Discounted Cash Flows and “Risk-as-feelings” Theory. The results of this study show evidence that income has a favourable impact on stock returns, while inflation dampens stock returns. Interestingly, the study also revealed that happiness is not significant in determining stock returns in these selected countries, indicating that the market participants are rational economic beings who always act in self-interest, making optimal decisions by trading off costs and benefits weighted by statistically correct probabilities.

JEL Codes: G100, G120

DOI : http://dx.doi.org/10.21102/gefj.2016.03.91.06