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Short Rates and Expected Asset Returns

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  • Kenneth A. Froot

Abstract

We present evidence that short-term interest rates forecast excess returns on many alternative assets: foreign exchange, stocks, bonds, and commodities. On average, a one percentage-point increase in short rates is associated with three percent lower annualized excess returns. To test whether this predictability is attributable to time-varying risk, independent measures of excess returns are formed using survey data on expected returns. We find similar predictability in these measures, too. Since the surveys don't include risk premia, the predictable components cannot be attributed to risk. We suggest that when short rates are high (low) investors are excessively optimistic (pessimistic) about alternative-asset returns.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 3247.

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Date of creation: Jan 1990
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Handle: RePEc:nbr:nberwo:3247

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  1. Frankel, Jeffrey A & Froot, Kenneth A, 1987. "Using Survey Data to Test Standard Propositions Regarding Exchange Rate Expectations," American Economic Review, American Economic Association, American Economic Association, vol. 77(1), pages 133-53, March.
  2. John Y. Campbell & Robert J. Shiller, 1986. "Cointegration and Tests of Present Value Models," Cowles Foundation Discussion Papers, Cowles Foundation for Research in Economics, Yale University 785, Cowles Foundation for Research in Economics, Yale University.
  3. Newey, Whitney & West, Kenneth, 2014. "A simple, positive semi-definite, heteroscedasticity and autocorrelation consistent covariance matrix," Applied Econometrics, Publishing House "SINERGIA PRESS", Publishing House "SINERGIA PRESS", vol. 33(1), pages 125-132.
  4. N. Gregory Mankiw & Lawrence H. Summers, 1987. "Do Long-Term Interest Rates Overreact to Short-Term Interest Rates?," NBER Working Papers, National Bureau of Economic Research, Inc 1345, National Bureau of Economic Research, Inc.
  5. Poterba, James M. & Summers, Lawrence H., 1988. "Mean reversion in stock prices : Evidence and Implications," Journal of Financial Economics, Elsevier, Elsevier, vol. 22(1), pages 27-59, October.
  6. Giovannini, Alberto & Jorion, Philippe, 1987. "Interest rates and risk premia in the stock market and in the foreign exchange market," Journal of International Money and Finance, Elsevier, Elsevier, vol. 6(1), pages 107-123, March.
  7. Robert J. Shiller & John Y. Campbell & Kermit L. Schoenholtz, 1983. "Forward Rates and Future Policy: Interpreting the Term Structure of Interest Rates," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, Economic Studies Program, The Brookings Institution, vol. 14(1), pages 173-224.
  8. French, Kenneth R, 1986. "Detecting Spot Price Forecasts in Futures Prices," The Journal of Business, University of Chicago Press, University of Chicago Press, vol. 59(2), pages S39-54, April.
  9. John F. O. Bilson, 1980. "The "Speculative Efficiency" Hypothesis," NBER Working Papers, National Bureau of Economic Research, Inc 0474, National Bureau of Economic Research, Inc.
  10. Baillie, Richard T & Bollerslev, Tim, 1989. " Common Stochastic Trends in a System of Exchange Rates," Journal of Finance, American Finance Association, American Finance Association, vol. 44(1), pages 167-81, March.
  11. Jeffrey A. Frankel & Kenneth A. Froot, 1985. "Using Survey Data to Test Some Standard Propositions Regarding Exchange Rate Expectations," NBER Working Papers, National Bureau of Economic Research, Inc 1672, National Bureau of Economic Research, Inc.
  12. Ferson, Wayne E, 1989. " Changes in Expected Security Returns, Risk, and the Level of Interest Rates," Journal of Finance, American Finance Association, American Finance Association, vol. 44(5), pages 1191-1217, December.
  13. Fama, Eugene F & French, Kenneth R, 1988. "Permanent and Temporary Components of Stock Prices," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 96(2), pages 246-73, April.
  14. Robert P. Flood & Robert J. Hodrick & Paul Kaplan, 1986. "An Evaluation of Recent Evidence on Stock Market Bubbles," NBER Working Papers, National Bureau of Economic Research, Inc 1971, National Bureau of Economic Research, Inc.
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