U.S. Economy and Global Stock Markets: Insights from a Distributional Approach

TL;DR

This paper introduces a novel matrix functional VAR approach to analyze cross-sectional return distributions across global markets, revealing how U.S. monetary policy influences both stock returns and their distributional characteristics.

Contribution

It extends existing models to jointly analyze multiple return distributions and macroeconomic indicators, providing a richer understanding of global financial interconnectedness.

Findings

U.S. contractionary monetary policy reduces global stock returns.

Policy dampens cross-sectional return kurtosis.

Framework enables conditional macro-financial forecasting.

Abstract

Financial markets are interconnected, with micro-currents propagating across global markets and shaping economic trends. This paper moves beyond traditional stock market indices to examine cross-sectional return distributions-15 in our empirical application, each representing a distinct global market. To facilitate this analysis, we develop a matrix functional VAR method with interpretable factors extracted from cross-sectional return distributions. Our approach extends the existing framework from modeling a single function to multiple functions, allowing for a richer representation of cross-sectional dependencies. By jointly modeling these distributions with U.S. macroeconomic indicators, we uncover the predictive power of financial market in forecasting macro-economic dynamics. Our findings reveal that U.S. contractionary monetary policy not only lowers global stock returns, as traditionally understood, but also dampens cross-sectional return kurtosis, highlighting an overlooked policy transmission. This framework enables conditional forecasting, equipping policymakers with a flexible tool to assess macro-financial linkages under different economic scenarios.