Relation Between Stock Returns And Economic Growth

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Many investors when making a decision regarding investing in a other country take into account certain factors which may play a very important role or may affect their future returns. Standard economics theory suggests that over the long run, profits or returns should rise in line with the economy/ economic growth, which is also the view point of many investors when making a decision.
Although the long run research and studies conducted by different economists gives a very different picture of the relationship between stock returns and economic growth, but very little empirical evidences to support the view with. Many economists and researchers supported the view that, stock returns and economic growth does not have a positive
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Jay.R Ritter in his research said that the main reason for a negative correlation between the two factors, according to him during high growth rate periods markets usually assign a high price/Earning and price to dividend multiples and which then lowers the realized returns because now more capital is required from the investors to in order to receive the same level of earning s and dividends from stocks.
From all these studies and empirical evidence it can be concluded that stock returns and economic growth are not related but have a negative correlation.
Ho= no correlation between economic growth and stock return.
H1= there is a relation between economic growth and stock returns
On the other hand the results for interest rates give the same type of results. The basic classical economics model suggests that there is a relationship between interest rates and economic growth. Usually reduction in the interest rates cause the level of growth to increase, this is because a reduction in interest rates makes borrowing more cheaper and encourages in investment in the economy, which eventually increases the growth rate. However, an increase in interest rates has an opposite effect on economic growth. According to (Suntum, 2008) high interest rated discourage investment as it’s more tempting to rather save the money and earn a decent interest rate, thus making the aggregate demand to fall which then badly affects the economic growth of
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