Does the U.S. extreme indicator matter in stock markets? International evidence

Abstract We propose a new predictor—the innovation in the daily return minimum in the U.S. stock market ( $$\Delta {MIN}^{US}$$ <mml:math xmlns:mml="http://www.w3.org/1998/Math/MathML"> <mml:mrow> <mml:mi>Δ</mml:mi> <mml:msup> <mml:mrow> <mml:mi>MIN</mml:mi> </mml:mrow> <mml:mrow> <mml:mi>US</mml:mi> </mml:mrow> </mml:msup> </mml:mrow> </mml:math> )—for predicting international stock market returns. Using monthly data for a wide range of 17 MSCI international stock markets during the period spanning over half a century from January 1972 to July 2022, we find that $$\Delta {MIN}^{US}$$ <mml:math xmlns:mml="http://www.w3.org/1998/Math/MathML"> <mml:mrow> <mml:mi>Δ</mml:mi> <mml:msup> <mml:mrow> <mml:mi>MIN</mml:mi> </mml:mrow> <mml:mrow> <mml:mi>US</mml:mi> </mml:mrow> </mml:msup> </mml:mrow> </mml:math> have strong predictive power for returns in most international stock markets: $$\Delta {MIN}^{US}$$ <mml:math xmlns:mml="http://www.w3.org/1998/Math/MathML"> <mml:mrow> <mml:mi>Δ</mml:mi> <mml:msup> <mml:mrow> <mml:mi>MIN</mml:mi> </mml:mrow> <mml:mrow> <mml:mi>US</mml:mi> </mml:mrow> </mml:msup> </mml:mrow> </mml:math> negatively predicts the next-month stock market returns. The results remain robust after controlling for a number of macroeconomic predictors and conducting subsample and panel data analyses, indicating that $$\Delta {MIN}^{US}$$ <mml:math xmlns:mml="http://www.w3.org/1998/Math/MathML"> <mml:mrow> <mml:mi>Δ</mml:mi> <mml:msup> <mml:mrow> <mml:mi>MIN</mml:mi> </mml:mrow> <mml:mrow> <mml:mi>US</mml:mi> </mml:mrow> </mml:msup> </mml:mrow> </mml:math> has significant predictive power and it outperforms other variables in international markets. Notably, $$\Delta {MIN}^{US}$$ <mml:math xmlns:mml="http://www.w3.org/1998/Math/MathML"> <mml:mrow> <mml:mi>Δ</mml:mi> <mml:msup> <mml:mrow> <mml:mi>MIN</mml:mi> </mml:mrow> <mml:mrow> <mml:mi>US</mml:mi> </mml:mrow> </mml:msup> </mml:mrow> </mml:math> demonstrates excellent predictive power even during the periods driven by financial upheavals (e.g., Global Financial Crisis and European Sovereign Debt Crisis). Both panel regressions and out-of-sample tests also support the robust predictive performance of $$\Delta {MIN}^{US}$$ <mml:math xmlns:mml="http://www.w3.org/1998/Math/MathML"> <mml:mrow> <mml:mi>Δ</mml:mi> <mml:msup> <mml:mrow> <mml:mi>MIN</mml:mi> </mml:mrow> <mml:mrow> <mml:mi>US</mml:mi> </mml:mrow> </mml:msup> </mml:mrow> </mml:math> . The predictive power, however, disappears during the non-financial crisis caused by COVID-19 pandemic, which is originated from the health sector rather than the financial sector. The results provide a new perspective on U.S. extreme indicator in stock market return predictability.