An International Analysis of Earnings, Stock Prices and Bond Yields

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.