Inflation, Stock Market and Long-Term Investors: Real Effects of Changing Demographics

Abstract:     
This paper shows the common demographic component shared by equity and bond yields. Life-cycle patterns in investment behavior appear as predictable components in financial yields and inflation. The slow-evolving time-series covariation due to changing population age structure explains two empirical puzzles: i) strong comovement between equity and bond markets, ii) positive correlation between equity yields and inflation. Out-of-sample forecasts, VAR simulations and predictive regressions support this conjecture. Specifications including both financial yields and a model-based demographic variable improve both equity and bond return predictability. A cross-country panel documents the cross-sectional variation of the demographic effect and explains the differences in comovement between equity and bond markets across countries.

Number of Pages in PDF File: 51

Keywords: demographics, inflation illusion, Fed model, return predictability, equity-bond comovement

JEL Classification: E27, E31, E44, G11, G12

working papers series