Bear Markets and Recessions versus Bull Markets and Expansions

TL;DR

This study investigates the asymmetric causal relationships between market phases and economic cycles in the US, revealing that bull and bear markets influence economic expansions and recessions, with policy implications for stabilizing the economy.

Contribution

It introduces asymmetric causality testing with bootstrap adjustments to analyze the impact of market phases on economic cycles during COVID-19.

Findings

Bear markets cause recessions

Bull markets cause expansions

Economic expansions influence bull markets

Abstract

This paper examines the dynamic interaction between falling and rising markets for both the real and the financial sectors of the largest economy in the world using asymmetric causality tests. These tests require that each underlying variable in the model be transformed into partial sums of the positive and negative components. The positive components represent the rising markets and the negative components embody the falling markets. The sample period covers some part of the COVID19 pandemic. Since the data is non normal and the volatility is time varying, the bootstrap simulations with leverage adjustments are used in order to create reliable critical values when causality tests are conducted. The results of the asymmetric causality tests disclose that the bear markets are causing the recessions as well as the bull markets are causing the economic expansions. The causal effect of bull markets on economic expansions is higher compared to the causal effect of bear markets on economic recessions. In addition, it is found that economic expansions cause bull markets but recessions do not cause bear markets. Thus, the policies that remedy the falling financial markets can also help the economy when it is in a recession.