Working Paper: NBER ID: w2047
Authors: Robert Barsky
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.
Keywords: Asset Pricing; Stock Prices; Bond Prices; Productivity Growth
JEL Codes: E44; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Drop in productivity growth (O49) | Decrease in equity values (G32) |
| Increase in risk (D81) | Decrease in equity values (G32) |
| Simultaneous decline in real interest rates (E43) | Decrease in equity values (G32) |
| Increase in risk (D81) | Increase in required return on equities (G12) |
| Increase in required return on equities (G12) | Decrease in stock prices (G10) |
| Drop in productivity growth (O49) | Increase in risk (D81) |
| Simultaneous decline in real interest rates (E43) | Increase in risk (D81) |