Macroeconomic Drivers of Equity Risk Premium Dynamics: Evidence from U.S. Financial Markets
Keywords:
Equity Risk Premium, Macroeconomic Indicators, U.S. Financial Markets, Stock Market Returns, Market VolatilityAbstract
Macroeconomics conditions are also important factors that influence financial market performance, investment risk and dynamics of equity return. By examining the correlation between economic indicators and the equity market, it is possible to assess financial stability and make informed investment decisions. This research investigated relationships between selected macroeconomic indicators, financial risk conditions and U.S equity market returns. Quantitative research was used with 523 monthly observations ranging from January 1981 to August 2024. Descriptive statistics, Pearson correlation, multiple linear regression, and historical period comparisons were performed on the secondary macro-financial data. Industrial production, retail sales, unemployment, housing starts, consumer sentiment and market volatility were analysed. The results showed that consumer sentiment was most positively correlated with S&P 500 returns (r = 0.325, p < 0.001) followed by retail sales growth (r = 0.213, p < 0.001). Market volatility was very negatively correlated (r = −0.183, p < 0.001). The regression model accounted for 18.4% of the variation in monthly returns. There was no significant difference between historical average return (1981-2000) and the average return for the last 24 years (2001-2024) (p = 0.140). The results provide insights into the importance of consumer expectations, economic activity, and financial uncertainty for the performance of the U.S. equity market. But the estimation of direct equity risk premium was constrained by the lack of similar risk-free returns so other financial indicators needed to be used.
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