Detecting the macroeconomic factors in Chinese stock market returns: A generalized dynamic factor model approach

This paper studies the macroeconomic factors in the stock market returns within a generalized dynamic factor approach This method enables us to summarize a large amount of economic information by few estimated factors and therefore avoids dimensional limitation of VAR or VEC model in this field. We pick out 78 series from the monthly economy indicators and financial variables in China spanning from 2005 to 2009 and find that latent macroeconomic factors - the “risk premium,” the “credit supply” and the “demand factor combined with the economic policy measures” -contain important information about the returns in Chinese stock market while the supply factor affects via risk premium on the following period.