Are macroeconomic factors adequate proxies for systematic influences in stock returns? A South African perspective

Published in: Investment Analysts Journal
Volume 49, issue 1, 2020 , pages: 34–52
DOI: 10.1080/10293523.2020.1723854
Author(s): Jan J. SzczygielskiDepartment of Financial Management, Gauteng, South Africa, Leon M. BrümmerDepartment of Financial Management, Gauteng, South Africa, Hendrik P. WolmaransDepartment of Financial Management, Gauteng, South Africa, Adam ZarembaDubai Business School, United Arab Emirates


We investigate whether macroeconomic factors adequately proxy for systematic influences in stock returns within the South African context. We also investigate whether a commonly used solution to factor omission in macroeconomic factor models, the residual market factor, adequately reflects systematic influences not reflected by a set of macroeconomic factors. Our contribution lies in precisely quantifying the ability of macroeconomic and residual market factors to proxy for systematic drivers of returns. Systematic influences are represented by statistically derived factor scores which are then related to a set of carefully selected macroeconomic factors. We find that the identification of macroeconomic factors that proxy for systematic influences is a challenge in itself. Once identified, macroeconomic factors are poor and unstable proxies for systematic influences and the use of a residual market factor does not significantly improve the approximation of factor scores. Our conclusion is that macroeconomic linear factor models are likely to be underspecified, even if a residual market factor is included. This has implications for researchers, investors, econometricians and economists that rely on macroeconomic factor models to study financial markets.

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