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On The Economic Link Between Asset Prices And Real Activity

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Author Info
Juan Ignacio Pena ()
Rosa Rodriguez ()
Abstract

This paper presents a model linking two financial markets (stocks and bonds) with the real business cycle, in the framework of the Consumption Capital Asset Pricing Model with Generalized Isoelastic Preferences. Besides interest rate term spread, the model includes a new variable to forecast economic activity: stock market term spread, which constitutes the slope of expected stock market returns. The empirical evidence documented in this paper suggests systematic relationships between the state of the business cycle and the shapes of two yield curves (interest rates and expected stock returns). Results are robust to changes in measures of economic growth, stock prices, interest rates and expectation-generating mechanisms.

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Paper provided by Universidad Carlos III, Departamento de Economía de la Empresa in its series Business Economics Working Papers with number wb063209.

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Date of creation: May 2006
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Handle: RePEc:cte:wbrepe:wb063209

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