The Yield Curve and the Stock Market: Mind the Long Run

46 Pages Posted: 5 Aug 2019

See all articles by Gonçalo Faria

Gonçalo Faria

Catholic University of Portugal (UCP) - School of Economics and Management and CEGE

Fabio Verona

Bank of Finland - Research

Date Written: July 10, 2019

Abstract

We extract cycles from the term spread and study their role for predicting the equity premium using linear models. When properly extracted, the trend of the term spread is a strong and robust out-of-sample equity premium predictor, both from a statistical and an economic point of view. It outperforms several variables recently proposed as good equity premium predictors. Our results support recent Findings in the asset pricing literature that the low-frequency components of macroeconomic variables play a crucial role in shaping the dynamics of equity markets. Hence, for policymakers and financial market participants interested in gauging equity market developments, the trend of the term spread is a promising variable to look at.

Keywords: equity premium, term spread, predictability, frequency domain

JEL Classification: C58, G11, G12, G17

Suggested Citation

Faria, Gonçalo and Verona, Fabio, The Yield Curve and the Stock Market: Mind the Long Run (July 10, 2019). Available at SSRN: https://ssrn.com/abstract=3430161 or http://dx.doi.org/10.2139/ssrn.3430161

Gonçalo Faria

Catholic University of Portugal (UCP) - School of Economics and Management and CEGE ( email )

Universidade Católica Portuguesa
Rua Diogo Botelho 1327
Porto, 4169-005
Portugal

Fabio Verona (Contact Author)

Bank of Finland - Research ( email )

P.O. Box 160
FIN-00101 Helsinki
Finland

HOME PAGE: http://bofcris.solenovo.fi/crisyp/disp/_/en/cr_redir_all/fet/fet/sea?direction=3&id=3827426

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