ABSTRACT
US BUSINESS INVESTMENT AND STOCK
RETURNS
This paper rekindles Keynes' position on investment outlays. It hypothesizes that the root cause of variation in U.S. stock returns lies in U.S. business investment and other fundamentals. An equation is estimated which relates changes in business investment relative to the Standard and Poor index to the volatility of investment and the squared volatility. The regression outcome from the Kalman filter utilizing the maximum likelihood method suggests that there is a positive relation between low levels of changes investment volatility and stock returns and a negative relation between high levels of squared volatility and stock returns, providing strong support evidence in favor of inverted U relationship between changes in investment and stock returns.  As a robust check, we added two other factors which are popular in predicting stock returns.