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Demography, stock prices and interest rates: The Easterlin hypothesis revisited

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Listed author(s):
  • Orrego, Fabrizio

    (Tepper School of Business Carnegie Mellon University)

Abstract

During the twentieth century, the U.S. witnessed a cyclical birth rate. This in turn shaped the evolution of the ratio of middle-age to young adults, or MY ratio, which captures the stance of the population pyramid at any given time. In this paper, I study the effects of demographic change, as measured by the MY ratio, on stock prices and interest rates. I construct an equilibrium model in the spirit of Geanakoplos et al. (2004). The model relates the economic fortune of a cohort to its relative size (Easterlin hypothesis) and matches qualitatively the long-run trends in real interest rates and stock prices in the U.S. postwar era. The first prediction of the model is that the price-earnings ratio and stock prices should be in phase with the MY ratio. The second prediction is that real interest rates should move inversely with the MY ratio, except after the peak in the MY ratio. Unlike Geanakoplos et al. (2004), this model does not predict that stock prices should move inversely with real interest rates. On the contrary, this model shows that in a stationary cyclic equilibrium there may be independent movements in stock and bond prices, which are necessary to prevent arbitrage opportunities.

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Paper provided by Banco Central de Reserva del Perú in its series Working Papers with number 2010-012.

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Date of creation: Sep 2010
Handle: RePEc:rbp:wpaper:2010-012
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Keywords: Overlapping generations; age structure; habits; consumption socialization;

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Find related papers by JEL classification:
  • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
  • J10 - Labor and Demographic Economics - - Demographic Economics - - - General

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  1. Abel, Andrew B, 1990. "Asset Prices under Habit Formation and Catching Up with the Joneses," American Economic Review, American Economic Association, vol. 80(2), pages 38-42, May.
  2. Nir Jaimovich & Henry E. Siu, 2009. "The Young, the Old, and the Restless: Demographics and Business Cycle Volatility," American Economic Review, American Economic Association, vol. 99(3), pages 804-826, June.
  3. Felix Kubler & Karl Schmedders, 2010. "Uniqueness of Steady States in Models with Overlapping Generations," Journal of the European Economic Association, MIT Press, vol. 8(2-3), pages 635-644, 04-05.
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  9. John Y. Campbell & John H. Cochrane, 1994. "By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," CRSP working papers 412, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  10. Author-Name: John Geanakoplos & Michael Magill & Martine Quinzii, 2004. "Demography and the Long-Run Predictability of the Stock Market," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 35(1), pages 241-326.
  11. Jose-Victor Rios Rull & Jonathan Heathcote & Dirk Krueger & Andy Glover, 2011. "Intergenerational Redistribution in the Great Recession," 2011 Meeting Papers 141, Society for Economic Dynamics.
  12. 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 1132-1145, December.
  13. Goenka, Aditya & Kelly, David L. & Spear, Stephen E., 1998. "Endogenous Strategic Business Cycles," Journal of Economic Theory, Elsevier, vol. 81(1), pages 97-125, July.
  14. Ulrike Malmendier & Stefan Nagel, 2011. "Depression Babies: Do Macroeconomic Experiences Affect Risk Taking?," The Quarterly Journal of Economics, Oxford University Press, vol. 126(1), pages 373-416.
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  16. Robin Brooks, 2002. "Asset-Market Effects of the Baby Boom and Social-Security Reform," American Economic Review, American Economic Association, vol. 92(2), pages 402-406, May.
  17. Kehoe, Timothy J. & Levine, David K. & Mas-Colell, Andreu & Woodford, Michael, 1991. "Gross substitutability in large-square economies," Journal of Economic Theory, Elsevier, vol. 54(1), pages 1-25, June.
  18. John Geanakoplos, 2008. "Overlapping Generations Models of General Equilibrium," Cowles Foundation Discussion Papers 1663, Cowles Foundation for Research in Economics, Yale University.
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