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An International Analysis of Earnings, Stock Prices and Bond Yields

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  • Alain Durré
  • Pierre Giot

Abstract

This paper assesses the contemporaneous relationship between stock prices, earnings and long-term government bond yields for a large number of countries. The time period of our data spans several decades. In a time series framework our analysis first tests the presence of a long-term contemporaneous relationship between these three variables (the so-called Fed model). Next, we assess if government bond yields play a significant role in the long-run relationship. Our empirical results question the validity of the Fed model in the sense that we show that long-term market movements are mainly driven by the earnings yield and not the differential between bond and earnings yields. As such, our analysis validates the results of Asness (2003) for a much larger collection of countries while using a dynamic time series (cointegration) framework. Finally, we also show that changes in long-term government bond yields have a short-term impact on stock prices. Copyright 2007 The Authors Journal compilation (c) 2007 Blackwell Publishing Ltd.

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Bibliographic Info

Article provided by Wiley Blackwell in its journal Journal of Business Finance & Accounting.

Volume (Year): 34 (2007-04)
Issue (Month): 3-4 ()
Pages: 613-641

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Handle: RePEc:bla:jbfnac:v:34:y:2007-04:i:3-4:p:613-641

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  1. Favero, Carlo A & Mosca, Federico, 2001. "Uncertainty on Monetary Policy and the Expectational Model of the Term Structure of Interest Rates," CEPR Discussion Papers 2748, C.E.P.R. Discussion Papers.
  2. Richard Clarida & Jordi Galí & Mark Gertler, 2000. "Monetary Policy Rules And Macroeconomic Stability: Evidence And Some Theory," The Quarterly Journal of Economics, MIT Press, vol. 115(1), pages 147-180, February.
  3. John Y. Campbell & Robert J. Shiller, 1989. "The Dividend-Price Ratio and Expectations of Future Dividends and Discount Factors," NBER Working Papers 2100, National Bureau of Economic Research, Inc.
  4. John Y. Campbell & Robert J. Shiller, 2001. "Valuation Ratios and the Long-Run Stock Market Outlook: An Update," NBER Working Papers 8221, National Bureau of Economic Research, Inc.
  5. Engle, Robert F & Granger, Clive W J, 1987. "Co-integration and Error Correction: Representation, Estimation, and Testing," Econometrica, Econometric Society, vol. 55(2), pages 251-76, March.
  6. John Y. Campbell & Robert J. Shiller, 1989. "Stock Prices, Earnings and Expected Dividends," NBER Working Papers 2511, National Bureau of Economic Research, Inc.
  7. John Y. Campbell & Robert J. Shiller, 1988. "Cointegration and Tests of Present Value Models," NBER Working Papers 1885, National Bureau of Economic Research, Inc.
  8. Randolph B. Cohen & Christopher Polk & Tuomo Vuolteenaho, 2005. "Money Illusion in the Stock Market: The Modigliani-Cohn Hypothesis," The Quarterly Journal of Economics, MIT Press, vol. 120(2), pages 639-668, May.
  9. Levin, Eric J & Wright, Robert E, 1998. "The Information Content of the Gilt-Equity Yield Ratio," The Manchester School of Economic & Social Studies, University of Manchester, vol. 66(0), pages 89-101, Supplemen.
  10. MacDonald, Ronald & Power, David, 1995. "Stock prices, dividends and retention: Long-run relationships and short-run dynamics," Journal of Empirical Finance, Elsevier, vol. 2(2), pages 135-151, June.
  11. S. I. Spyrou, 2004. "Are stocks a good hedge against inflation? evidence from emerging markets," Applied Economics, Taylor & Francis Journals, vol. 36(1), pages 41-48.
  12. Richard D.F. Harris & Rene Sanchez-Valle, 2000. "The Gilt-Equity Yield Ratio and the Predictability of UK and US Equity Returns," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 27(3-4), pages 333-357.
  13. Joel Lander & Athanasios Orphanides & Martha Douvogiannis, 1997. "Earnings forecasts and the predictability of stock returns: evidence from trading the S&P," Finance and Economics Discussion Series 1997-6, Board of Governors of the Federal Reserve System (U.S.).
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Cited by:
  1. Bandholz, Harm & Clostermann, Jörg & Seitz, Franz, 2007. "Explaining the US bond yield conundrum," OTH im Dialog: Weidener Diskussionspapiere 2, University of Applied Sciences Amberg-Weiden (OTH).
  2. GIOT, Pierre & PETITJEAN, Mikael, 2006. "Short-term market timing using the Bond-Equity Yield Ratio," CORE Discussion Papers 2006090, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  3. GIOT, Pierre & PETITJEAN, Mikael, 2005. "Dynamic asset allocation between stocks and bonds using the Bond-Equity Yield Ratio," CORE Discussion Papers 2005010, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  4. Joseph Friedman & Yochanan Shachmurove, 2005. "European Stock Market Dynamics Before and After the Introduction of the Euro," PIER Working Paper Archive 05-028, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
  5. Guglielmo Maria Caporale & Luis A. Gil-Alana, 2011. "Fractional Integration and Cointegration in US Financial Time Series Data," CESifo Working Paper Series 3416, CESifo Group Munich.
  6. Migiakis, Petros M. & Bekiris, Fivos V., 2009. "Regime switches between dividend and bond yields," International Review of Financial Analysis, Elsevier, vol. 18(4), pages 198-204, September.
  7. Giot, Pierre & Petitjean, Mikael, 2007. "The information content of the Bond-Equity Yield Ratio: Better than a random walk?," International Journal of Forecasting, Elsevier, vol. 23(2), pages 289-305.
  8. Jokivuolle, Esa & Keppo, Jussi, 2014. "Bankers' compensation: Sprint swimming in short bonus pools?," Research Discussion Papers 2/2014, Bank of Finland.

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