The Co-Movement Puzzle

Abstract

This paper studies the co-movement between discount rates on housing, equity, and corporate bonds, in long-run data covering 17 countries over 150 years. Standard theories in macro-finance imply strongly positive co-movement attributable to variation in a cross-asset discount factor (typically, through changes in risk aversion and macroeconomic risk). In the data, this co-movement is absent. I show that asset-specific discount rates are uncorrelated, and asset valuations predict returns within individual asset classes, but not across asset classes. Variance decomposition attributes most asset price movements to asset-class-specific discount rates, a considerable part to cashflows, and almost none to common cross-asset-class discount rate variation. My findings have important implications for both risk-based and behavioural theories of asset price formation, suggesting that asset-specific risk factors, and subjective expectations of asset-specific risks and cashflows are key.

Keywords: discount rates, risk premia, co-movement, return predictability, excess volatility, equities, corporate bonds, real estate

JEL Classification: G12, G15, G17, E44, N20