Why Don't the Prices of Stocks and Bonds Move Together?
33 Pages Posted: 5 Jul 2004 Last revised: 7 Aug 2022
Date Written: October 1986
Abstract
The very low real interest rates on bonds in the 1970's were accompanied by a large drop in the value of common stocks relative to dividends and earnings. More generally, a number of authors have demonstrated that the real prices of debt and equity claims do not covary closely, and often move in opposite directions. This paper analyzes the effects of two disturbances - an increase in risk, and a slowing of productivity growth - each of which might rationalize a simultaneous drop in equity values and in real interest rates on bonds. As long as marginal utility is a convex function of consumption, an increase in risk depresses the return on riskless bonds. When all of the wealth of the economy is traded in the stock market, equity values fall with increasing equity risk only if the intertemporal elasticity of substitution in consumption exceeds unity. This same pattern occurs in response to a fall in productivity growth. In a richer two-real-asset model, which takes account of the fact that corporate capital has rarely been more than a quarter of total wealth, it is likely that both increased risk and lower productivity growth in the corporate sector would lead to a fall in stock prices, a drop in real interest rates, and a rise in the price of the second tangible asset -the pattern seen in the 1910's.
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
What Moves the Stock and Bond Markets? A Variance Decomposition for Long-Term Asset Returns
By John Y. Campbell and John Ammer
-
By Eugene F. Fama and Kenneth R. French
-
Who Underreacts to Cash-Flow News? Evidence from Trading between Individuals and Institutions
By Randolph B. Cohen, Paul A. Gompers, ...
-
By Randolph B. Cohen, Christopher Polk, ...
-
The Capital Asset Pricing Model: Theory and Evidence
By Eugene F. Fama and Kenneth R. French