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What Moves The Stock And Bond Markets? A Variance Decomposition For Long- Term Asset Returns

  • Campbell, J.Y.
  • Ammer, J.

This paper uses a log-linear asset pricing framework and a vector autoregressive model to break down movements in stock and bond returns into changes in expectations of future stock dividends, inflation, short-term real interest rates, and excess returns on stocks and bonds. In monthly postwar U.S. data, excess stock returns are found to be driven largely by news about future excess stock returns, while excess 10-year bond returns are driven largely by news about future inflation. Real interest rate changes have little impact on either stock or 10-year bond returns, although they do affect the short-term nominal interest rate and the slope of the term structure. These findings help to explain why postwar excess stock and bond returns have been almost uncorrelated.

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Paper provided by Princeton, Department of Economics - Financial Research Center in its series Papers with number 127.

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Length: 40 pages
Date of creation: 1991
Date of revision:
Handle: RePEc:fth:prinec:127
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  1. David M. Cutler & James M. Poterba & Lawrence H. Summers, 1988. "What Moves Stock Prices?," NBER Working Papers 2538, National Bureau of Economic Research, Inc.
  2. John Y. Campbell & Robert J. Shiller, 1983. "A Simple Account of the Behavior of Long-Term Interest Rates," NBER Working Papers 1203, National Bureau of Economic Research, Inc.
  3. Campbell, John, 1990. "Measuring the Persistence of Expected Returns," Scholarly Articles 3207696, Harvard University Department of Economics.
  4. Campbell, John Y., 1987. "Stock returns and the term structure," Journal of Financial Economics, Elsevier, vol. 18(2), pages 373-399, June.
  5. John Y. Campbell & Robert J. Shiller, 1986. "The Dividend-Price Ratio and Expectations of Future Dividends and Discount Factors," NBER Working Papers 2100, National Bureau of Economic Research, Inc.
  6. Campbell, J.Y. & Shiller, R.J., 1988. "Stock Prices, Earnings And Expected Dividends," Papers 334, Princeton, Department of Economics - Econometric Research Program.
  7. Nelson, C.R. & Kim, M.J., 1990. "Predictable Stock Returns: Reality Or Statistical Illusion?," Discussion Papers in Economics at the University of Washington 90-15, Department of Economics at the University of Washington.
  8. Frederic S. Mishkin, 1988. "What Does the Term Structure Tell Us About Future Inflation?," NBER Working Papers 2626, National Bureau of Economic Research, Inc.
  9. Barsky, Robert B, 1989. "Why Don't the Prices of Stocks and Bonds Move Together?," American Economic Review, American Economic Association, vol. 79(5), pages 1132-45, December.
  10. Campbell, John Y, 1991. "A Variance Decomposition for Stock Returns," Economic Journal, Royal Economic Society, vol. 101(405), pages 157-79, March.
  11. Cutler, David M & Poterba, James M & Summers, Lawrence H, 1991. "Speculative Dynamics," Review of Economic Studies, Wiley Blackwell, vol. 58(3), pages 529-46, May.
  12. Andrew W. Lo, A. Craig MacKinlay, 1988. "Stock Market Prices do not Follow Random Walks: Evidence from a Simple Specification Test," Review of Financial Studies, Society for Financial Studies, vol. 1(1), pages 41-66.
  13. Shiller, Robert J. & Huston McCulloch, J., 1990. "The term structure of interest rates," Handbook of Monetary Economics, in: B. M. Friedman & F. H. Hahn (ed.), Handbook of Monetary Economics, edition 1, volume 1, chapter 13, pages 627-722 Elsevier.
  14. 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.
  15. Fama, Eugene F. & Schwert, G. William, 1977. "Asset returns and inflation," Journal of Financial Economics, Elsevier, vol. 5(2), pages 115-146, November.
  16. Fama, Eugene F. & French, Kenneth R., 1988. "Dividend yields and expected stock returns," Journal of Financial Economics, Elsevier, vol. 22(1), pages 3-25, October.
  17. Hodrick, Robert J, 1992. "Dividend Yields and Expected Stock Returns: Alternative Procedures for Inference and Measurement," Review of Financial Studies, Society for Financial Studies, vol. 5(3), pages 357-86.
  18. Arturo Estrella & Gikas A. Hardouvelis, 1989. "The term structure as a predictor of real economic activity," Research Paper 8907, Federal Reserve Bank of New York.
  19. Shiller, Robert & Campbell, John, 1991. "Yield Spreads and Interest Rate Movements: A Bird's Eye View," Scholarly Articles 3221490, Harvard University Department of Economics.
  20. Litterman, Robert B & Weiss, Laurence M, 1985. "Money, Real Interest Rates, and Output: A Reinterpretation of Postwar U.S. Data," Econometrica, Econometric Society, vol. 53(1), pages 129-56, January.
  21. Shiller, Robert J. & Beltratti, Andrea E., 1992. "Stock prices and bond yields : Can their comovements be explained in terms of present value models?," Journal of Monetary Economics, Elsevier, vol. 30(1), pages 25-46, October.
  22. 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, vol. 14(1), pages 173-224.
  23. Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, vol. 50(4), pages 1029-54, July.
  24. 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.
  25. Cecchetti, Stephen G & Lam, Pok-sang & Mark, Nelson C, 1990. "Mean Reversion in Equilibrium Asset Prices," American Economic Review, American Economic Association, vol. 80(3), pages 398-418, June.
  26. Bruce N. Lehmann, 1991. "Earnings, Dividend Policy, and Present Value Relations: Building Blocks of Dividend Policy Invariant Cash Flows," NBER Working Papers 3676, National Bureau of Economic Research, Inc.
  27. James H. Stock & Mark W. Watson, 1990. "Business Cycle Properties of Selected U.S. Economic Time Series, 1959-1988," NBER Working Papers 3376, National Bureau of Economic Research, Inc.
  28. James M. Poterba & Lawrence H. Summers, 1987. "Mean Reversion in Stock Prices: Evidence and Implications," NBER Working Papers 2343, National Bureau of Economic Research, Inc.
  29. Gibbons, Michael R., 1989. "On the volatility of bond prices," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 31(1), pages 139-175, January.
  30. Donald B. Keim & Robert F. Stambaugh, . "Predicting Returns in the Stock and Bond Markets," Rodney L. White Center for Financial Research Working Papers 15-85, Wharton School Rodney L. White Center for Financial Research.
  31. Matthew Richardson & James H. Stock, 1990. "Drawing Inferences From Statistics Based on Multi-Year Asset Returns," NBER Working Papers 3335, National Bureau of Economic Research, Inc.
  32. Fama, Eugene F & Bliss, Robert R, 1987. "The Information in Long-Maturity Forward Rates," American Economic Review, American Economic Association, vol. 77(4), pages 680-92, September.
  33. Fama, Eugene F., 1990. "Term-structure forecasts of interest rates, inflation and real returns," Journal of Monetary Economics, Elsevier, vol. 25(1), pages 59-76, January.
  34. Conrad, Jennifer & Kaul, Gautam, 1988. "Time-Variation in Expected Returns," The Journal of Business, University of Chicago Press, vol. 61(4), pages 409-25, October.
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