Predictability of Growth in Emerging Markets : Information in Financial Aggregates

This paper tests for predictability of output growth in a panel of twenty-two emerging market economies. We use pooled panel data methods that control for endogeneity and persistence in the predictor variables to test the predictive power of a large set of financial aggregates including valuation measures, interest rates, and capital flows. Empirical evidence suggests that stock returns, portfolio investment flows, the term spread and default spreads help predict output growth in emerging markets. In particular, large capital inflows predict subsequent high GDP growth as do high term spreads. Conversely, higher default spreads on emerging market government debt signals lower future GDP growth. We also find evidence that the performance of aggregates such as global commodity markets, a cross-sectional firm size factor, and returns on the market portfolio contain information about the future state of the economy. We benchmark our results against the US and find that there are differences in information flows and the role of capital markets in predicting economic growth. Our analysis extends previous findings in the macro- finance literature on the links between the real economy and financial market performance