Macroeconomic Forces and Arbitrage Pricing Theory

ABSTRACT This paper tests five macroeconomic variables that have been both theorized to affect stock returns and been proven to do so in past empirical research. Those variables are risk premium, industrial production, term structure, expected inflation, and unexpected inflation. The variables are retested for their statistical significance using four years of monthly contemporary data for six different countries (developed and developing). The United States is used as a benchmark, in addition to the ASEAN-5 (Singapore, Thailand, Philippines, Malaysia, and Indonesia). This study finds that risk premium and industrial production were significant over the sample, but term structure, expected inflation, and unexpected inflation were not significant in explaining domestic market returns. Furthermore, principal component regressions outperformed cross-sectional ones, with factor analysis as the least statistically significant model. For the six countries tested, the arbitrage pricing theory was also found to be a less robust pricing tool than the capital asset pricing model.