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

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  • 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.

Suggested Citation

  • Orrego, Fabrizio, 2010. "Demography, stock prices and interest rates: The Easterlin hypothesis revisited," Working Papers 2010-012, Banco Central de Reserva del Perú.
    • Handle: RePEc:rbp:wpaper:2010-012
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    References listed on IDEAS

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    Keywords

    Overlapping generations; age structure; habits; consumption socialization;
    All these keywords.

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