Expected Inflation, Interest Rates, and Stock Returns

This paper documents a long‐lived asymmetrical relationship between interest rate changes and subsequent stock returns. Drops in interest rates are followed by twelve months of excess stock returns, while increases in interest rates have little effect. The results are robust to the choices of short‐...

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Bibliographic Details
Published in:The Financial review (Buffalo, N.Y.) N.Y.), 1996-11, Vol.31 (4), p.809-830
Main Authors: Domian, Dale L., Gilster, John E., Louton, David A.
Format: Article
Language:English
Subjects:
Economic models
Inflation
Interest rates
Statistical analysis
Stock prices
Studies
Time series
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Summary:This paper documents a long‐lived asymmetrical relationship between interest rate changes and subsequent stock returns. Drops in interest rates are followed by twelve months of excess stock returns, while increases in interest rates have little effect. The results are robust to the choices of short‐term interest rate and stock index. These findings cannot be explained by Geske and Roll's [10] reversed causality argument; nor do they appear to result from periods of unusual interest rates or stock returns. Since interest rate changes are generally used as proxies for changes in expected inflation, the results provide new insights into previous research on inflation and stock returns, and there are important implications for the literature on time‐varying risk premia.
ISSN:0732-8516
1540-6288
DOI:10.1111/j.1540-6288.1996.tb00898.x