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Expected Inflation, Interest Rates, and Stock Returns

Author

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  • Domian, Dale L
  • Gilster, John E
  • Louton, David A

Abstract

This paper documents a long-lived asymmetrical relationship between interest rate changes and subsequent stock returns. Drops in interest rates are followed by twelve months of excess stock returns, while increases in interest rates have little effect. The results are robust to the choices of short-term interest rate and stock index. These findings cannot be explained by Geske and Roll's reversed causality argument; nor do they appear to result from periods of unusual interest rates or stock returns. Since interest rate changes are generally used as proxies for changes in expected inflation, the results provide new insights into previous research on inflation and stock returns, and there are important implications for the literature on time-varying risk premia. Copyright 1996 by MIT Press.

Suggested Citation

  • Domian, Dale L & Gilster, John E & Louton, David A, 1996. "Expected Inflation, Interest Rates, and Stock Returns," The Financial Review, Eastern Finance Association, vol. 31(4), pages 809-830, November.
    • Handle: RePEc:bla:finrev:v:31:y:1996:i:4:p:809-30
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    Cited by:

    1. Kenneth Kalu, 2017. "A Re-Examination of the Asymmetry between Interest Rates and Stock Returns," International Journal of Economics and Finance, Canadian Center of Science and Education, vol. 9(6), pages 23-30, June.
    2. Doron Nissim & Stephen H. Penman, 2003. "The Association between Changes in Interest Rates, Earnings, and Equity Values," Contemporary Accounting Research, John Wiley & Sons, vol. 20(4), pages 775-804, December.
    3. Chi-Fai Lo & Cho-Hoi Hui, 2016. "Pricing Corporate Bonds With Interest Rates Following Double Square-root Process," Working Papers 112016, Hong Kong Institute for Monetary Research.
    4. Bwo‐Nung Huang & Chin‐Wei Yang, 2004. "Industrial output and stock price revisited: an application of the multivariate indirect causality model," Manchester School, University of Manchester, vol. 72(3), pages 347-362, June.
    5. Clive Coetzee, 2002. "Monetary Conditions and Stock Returns: A South African Case Study," Finance 0205002, University Library of Munich, Germany.
    6. Somayeh Madadpour & Mohsen Asgari, 2019. "The puzzling relationship between stocks return and inflation: a review article," International Review of Economics, Springer;Happiness Economics and Interpersonal Relations (HEIRS), vol. 66(2), pages 115-145, June.
    7. Chi-Fai Lo & Cho-Hoi Hui, 2016. "Pricing corporate bonds with interest rates following double square-root process," International Journal of Financial Engineering (IJFE), World Scientific Publishing Co. Pte. Ltd., vol. 3(03), pages 1-31, September.
    8. Guan-Ru Chen & Ming-Hung Wu, 2013. "How does Monetary Policy Influence Capital Markets? Using a Threshold Regression Model," Asia-Pacific Financial Markets, Springer;Japanese Association of Financial Economics and Engineering, vol. 20(1), pages 31-47, March.
    9. Vygodina, Anna V., 2006. "Effects of size and international exposure of the US firms on the relationship between stock prices and exchange rates," Global Finance Journal, Elsevier, vol. 17(2), pages 214-223, December.
    10. Zaremba, Adam & Cakici, Nusret & Bianchi, Robert J. & Long, Huaigang, 2023. "Interest rate changes and the cross-section of global equity returns," Journal of Economic Dynamics and Control, Elsevier, vol. 147(C).
    11. Fabian Herweg & Maximilian Kähny, 2022. "Do Zombies Rise when Interest Rates Fall? A Relationship Banking Model," CESifo Working Paper Series 9628, CESifo.
    12. Kaehny, Maximilian & Herweg, Fabian, 2022. "Do Zombies Rise When Interest Rates Fall? A Relationship-Banking Model," VfS Annual Conference 2022 (Basel): Big Data in Economics 264126, Verein für Socialpolitik / German Economic Association.
    13. Du, Ding, 2006. "Monetary policy, stock returns and inflation," Journal of Economics and Business, Elsevier, vol. 58(1), pages 36-54.

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