Yield Curve Shifts and the Cross-Section of Global Equity Returns

Abstract

Interest rate changes typically affect equity value adversely. However, if investors react slowly, then the repricing may stretch over time. Using a century of data from sixty countries, we demonstrate that past yield curve shifts predict the cross-section of equity risk premia worldwide. The quintile of stock markets with the highest change in government bond yields underperforms the countries with the lowest change by 0.76% per month. The phenomenon is distinctly robust and cannot be explained by known risk factors. Furthermore, the low correlation with other cross return patterns paves the way for effective country allocation strategies.

Keywords: yield curve, government bonds, country equity indexes, interest rates, international markets, asset pricing, return predictability, the cross-section of stock returns

JEL Classification: G11, G12, G14, G15, N20