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Stock Prices and Bond Yields: Can Their Co-Movements Be Explained in Terms of Present Value Models?

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Abstract

Real stock prices seem to overreact to changes in long-term interest rates. That is, real stock prices drop when long-term interest rates rise (and rise when they fall) more than would be implied by a rational expectationspresent value model where expectations are based on a vector autoregression. This overreaction is not associated with any overreaction to changes in the short-run inflation rate. Over the last century real stock prices have shown little reaction to changes in inflation rates, and according to the model they should show little reaction. These conclusions were reached from an analysis of annual data in the United States 1871 to 1989 and the United Kingdom 1918 to 1989.

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Paper provided by Cowles Foundation for Research in Economics, Yale University in its series Cowles Foundation Discussion Papers with number 953.

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Length: 33 pages
Date of creation: Sep 1990
Date of revision:
Publication status: Published in Journal of Monetary Economics (1992), 30: 25-46
Handle: RePEc:cwl:cwldpp:953

Note: CFP 833.
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  1. Campbell, John Y & Shiller, Robert J, 1988. " Stock Prices, Earnings, and Expected Dividends," Journal of Finance, American Finance Association, vol. 43(3), pages 661-76, July.
  2. Kleidon, Allan W, 1988. "The Probability of Gross Violations of a Present Value Variance Inequality: Reply," Journal of Political Economy, University of Chicago Press, vol. 96(5), pages 1093-96, October.
  3. John Y. Campbell & Robert J. Shiller, 1986. "Cointegration and Tests of Present Value Models," Cowles Foundation Discussion Papers 785, Cowles Foundation for Research in Economics, Yale University.
  4. Andrea E. Beltratti & Robert J. Shiller, 1991. "Actual and Warranted Relations Between Asset Prices," Cowles Foundation Discussion Papers 970, Cowles Foundation for Research in Economics, Yale University.
  5. Robert B. Barsky, 1986. "Why Don't the Prices of Stocks and Bonds Move Together?," NBER Working Papers 2047, National Bureau of Economic Research, Inc.
  6. Fama, Eugene F. & French, Kenneth R., 1989. "Business conditions and expected returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 25(1), pages 23-49, November.
  7. Fama, Eugene F & French, Kenneth R, 1988. "Permanent and Temporary Components of Stock Prices," Journal of Political Economy, University of Chicago Press, vol. 96(2), pages 246-73, April.
  8. Campbell, John, 1987. "Stock Returns and the Term Structure," Scholarly Articles 3207699, Harvard University Department of Economics.
  9. Bulkley, George & Tonks, Ian, 1989. "Are U.K. Stock Prices Excessively Volatile? Trading Rules and Variance Bounds Tests," Economic Journal, Royal Economic Society, vol. 99(398), pages 1083-98, December.
  10. Shiller, Robert J, 1988. "The Probability of Gross Violations of a Present Value Variance Inequality," Journal of Political Economy, University of Chicago Press, vol. 96(5), pages 1089-92, October.
  11. Campbell, John Y, 1990. "Measuring the Persistence of Expected Returns," American Economic Review, American Economic Association, vol. 80(2), pages 43-47, May.
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