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Hi i am trying to prove that there is a relationship between stock market index (FTSE) and monetary policy fundamentals such as Interest rates(IR), Inflation (CPI), long-term interest rates (LTIR) and Money supply(M3). I tried running a regression and R squared was very low, something around 2%, which logically is not suppose to be so low. So my professor told me that because it takes a few months for monetary policy to actually filter into the market i should include lags. So what he told me to do is to do "dual cointegration estimation" for each independent variable separately e.g. FTSE IR(6) ; FTSE CPI(6) etc. and then he said i should check which ones are actually significant and only include those into the regression.
Now my question is firstly when i estimate an equation as my professor wrote for me FTSE IR(6) , isnt it suppose to be (-6) rather than (6). Secondly when i do that what am i suppose to look at to see if its significant or not, because R2 is still always low and he told that i could use ECM for that, so im not really sure what am i suppose to look at.
Also once i find which ones are significant and which ones arent how do i put significant ones into the regression equation? My professor didnt just mean that some variables will be significant and some wont, he actually said that some lags will be significant and some wont so for example IR t-1 will be and IR t-2 wont.
I know this doesnt sound very clear but im hoping someone could helo me with this, because im very lost.