STOCK-PRICES AND BOND YIELDS - CAN THEIR COMOVEMENTS BE EXPLAINED IN TERMS OF PRESENT VALUE MODELS

Real stock prices do not show the relation to long-term interest rates that a simple rational expectations present value model would imply. Real stock prices drop when long-term interest rates rise (and rise when they fall) more than would be implied by this vector autoregression model. In contrast, over the last century changes in real stock prices have shown little correlation with changes in inflation rates, and according to the present value model they should show little correlation. These conclusions were reached from an analysis of annual data in the United States, 1871-1989, and the United Kingdom, 1918-1989.