What drives financial markets? Real-time macroeconomic indicators
Working paper no 42, 2006
It is difficult to identify the driving forces behind financial market developments as they are not directly observable. The paper argues that correlations between asset prices in different markets can be used to infer which of five macroeconomic factors that drive markets (growth and inflation in the euro area and the US respectively and global risk appetite). The asset pricing in the model follows standard finance theory, but the resulting indicators are novel. The indicators are useful as they are objective, consistent, based on actual market developments, quantitative and available in real-time. The history of the indicators also passes a “reality check”.