Economic Activty - Business Cycles and Security Prices -
IB, SAPM Concept
The knol will have brief introduction to the concept, links to various knols on the concept, books on the concept and research papers on the concept.
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Concept Definition and Explanation
Fluctuations in security market price levels are related to changes in the aggregate economy.
Business cycles keep occuring in aggregate economy.
Shishkin explains that the business cycle concept has been developed from the sequence of events discerned in the historical study of eocnomic activity. Periods business expansion appear to cumulate to peaks. As they cumulate, contrary forces tend ot gain strength, bringing about a reversal in business activity and the onset of a recession. As a recession continue, forces for an expansion gradually emerge and they become dominant and a recovery begins.
National Bureau of Economic Research (NBER) has examined the relationship of alternative economic series to the behavior of aggregate economic activity. They identified a strong relationship between stock market price level and aggregate economy fluctuations.
Stock price more consistently turn before the economy does. Thus stock market price level is classified as a leading indicator.
Why stock prices fluctuate in relation to business cycles? As investors attempt to estimate future variables, expected recessions depress their estimates of corporate earnings and hence share prices.
Trading in stock market is popular using the relationship between business cycles and stock prices.
References:
Reilly, Frank and Keith Brown, Investment Analysis and Portfolio Management, 7th Edition, Thomson-South Western, 2003
Julius Shishkin, "Business Cycle INdicators: The Known and the Unknown," Review of the INternational Statistical Institute 31. No. 3, (1963), Pp.361-383
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