The interactions among stock returns, the term structure of interest rates and economic activities: Evidence from Taiwan

Abstract

Both stock returns and the term structure of interest rates are rich in information, in particular, they
could be used to forecast economic activities. Nevertheless, it is necessary to further clarify the relation
between stock returns and the term structure of interest rates, and compare the relation of the two
variables with economic activities. Our research combined various research methods of time series,
including VAR, Granger Causality Test, Impulse Response Function and Variance Decomposition to
explore the interactions among stock returns, the term structure of interest rates and economic
activities in Taiwan. Research result indicated that the causality existed not only in the relation between
stock returns and industrial production but in the relation between stock returns and the spread
between long-term and short-term interest rates (hereinafter “the spread”). In addition, when an abrupt
shock happened to stock returns, it also had obvious influence on industrial production and the spread.
But there is no causality or feedback in the interaction of the spread and industrial production, and the
response of industrial production to the spread is not obvious, whether it is in the long-term or shortterm. These results indicated that in Taiwan the term structure of interest rates was not a good indicator
of economic activities and stock returns were superior to the term structure of interest rates as the
leading indicator.