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

  • Orrego, Fabrizio

    (Tepper School of Business Carnegie Mellon University)

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
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Handle: RePEc:rbp:wpaper:2010-012
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  1. Felix Kuber & Karl Schmedders, 2007. "Competitive Equilibria in Semi-Algebraic Economies," PIER Working Paper Archive 07-013, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
  2. John Geanakoplos & Michael Magill & Martine Quinzii, 2002. "Demography and the Long-run Predictability of the Stock Market," Cowles Foundation Discussion Papers 1380, Cowles Foundation for Research in Economics, Yale University.
  3. Glover, Andrew & Heathcote, Jonathan & Krueger, Dirk & Ríos-Rull, José-Víctor, 2011. "Intergenerational Redistribution in the Great Recession," CEPR Discussion Papers 8329, C.E.P.R. Discussion Papers.
  4. John Geanakoplos, 2008. "Overlapping Generations Models of General Equilibrium," Cowles Foundation Discussion Papers 1663, Cowles Foundation for Research in Economics, Yale University.
  5. 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 804-26, June.
  6. James Poterba, 2004. "The Impact of Population Aging on Financial Markets," NBER Working Papers 10851, National Bureau of Economic Research, Inc.
  7. 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.
  8. Grandmont Jean-michel, 1983. "On endogenous competitive business cycles," CEPREMAP Working Papers (Couverture Orange) 8316, CEPREMAP.
  9. 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.
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  11. Azariadis, Costas & Guesnerie, Roger, 1986. "Sunspots and Cycles," Review of Economic Studies, Wiley Blackwell, vol. 53(5), pages 725-37, October.
  12. Andrew B. Abel, . "Asset Prices Under Habit Formation and Catching Up With the Jones," Rodney L. White Center for Financial Research Working Papers 1-90, Wharton School Rodney L. White Center for Financial Research.
  13. Balasko, Yves & Cass, David & Shell, Karl, 1980. "Existence of competitive equilibrium in a general overlapping-generations model," Journal of Economic Theory, Elsevier, vol. 23(3), pages 307-322, December.
  14. 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.
  15. 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.
  16. Ulrike Malmendier & Stefan Nagel, 2009. "Depression Babies: Do Macroeconomic Experiences Affect Risk-Taking?," NBER Working Papers 14813, National Bureau of Economic Research, Inc.
  17. 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.
  18. John Geanakoplos, 2008. "Overlapping Generations Models of General Equilibrium," Levine's Working Paper Archive 122247000000002225, David K. Levine.
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