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Interactive effect of changes in the shape of the yield curve and conditional term spread on expected equity returns

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  • David A. Volkman
  • Olivier J.P. Maisondieu Laforge
  • Mark Wohar

Abstract

Recent research has noted that the change in the shape of the yield curve can serve as a proxy for economic activity and contains economic information not present in other explanatory variables. This article extends previous research by examining the combined effect of changes in the shape of the yield curve (yield pattern) and term spread on ex ante equity returns. We find specific yield patterns do affect future equity returns, that changes in the expected long rate is a significant factor, and that, when conditioned on the change in yield curve, the term spread is time variant and significant in specific yield pattern environments and insignificant in others. Specifically, we find that average ex ante equity returns are significant and positive when the yield pattern shows signs of the expected long rate declining. In addition, we find the efficacy of the conditional term spread to predict future equity returns increased after 1980. Our results are consistent with the Expectation Theory of interest rates and robust across capitalization and industry classification.

Suggested Citation

  • David A. Volkman & Olivier J.P. Maisondieu Laforge & Mark Wohar, 2012. "Interactive effect of changes in the shape of the yield curve and conditional term spread on expected equity returns," Applied Financial Economics, Taylor & Francis Journals, vol. 22(18), pages 1491-1500, September.
  • Handle: RePEc:taf:apfiec:v:22:y:2012:i:18:p:1491-1500 DOI: 10.1080/09603107.2012.663471
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    References listed on IDEAS

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    1. Andreas Hoffmann, 2010. "An Overinvestment Cycle In Central And Eastern Europe?," Metroeconomica, Wiley Blackwell, vol. 61(4), pages 711-734, November.
    2. Andreas Hoffmann & Gunther Schnabl, 2011. "A Vicious Cycle of Manias, Crises and Asymmetric Policy Responses – An Overinvestment View," The World Economy, Wiley Blackwell, vol. 34(3), pages 382-403, March.
    3. Paul Grauwe & Gunther Schnabl, 2004. "EMU entry strategies for the new member states," Intereconomics: Review of European Economic Policy, Springer;German National Library of Economics;Centre for European Policy Studies (CEPS), vol. 39(5), pages 241-246, September.
    4. Eling, Martin & Schuhmacher, Frank, 2007. "Does the choice of performance measure influence the evaluation of hedge funds?," Journal of Banking & Finance, Elsevier, vol. 31(9), pages 2632-2647, September.
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    Cited by:

    1. Rangan Gupta & Marian Risse & David A. Volkman & Mark E. Wohar, 2017. "The Role of Term Spread and Pattern Changes in Predicting Stock Returns and Volatility of the United Kingdom: Evidence from a Nonparametric Causality-in-Quantiles Test Using Over 250 Years of Data," Working Papers 201755, University of Pretoria, Department of Economics.

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