Interest Rate Changes and the Cross-Section of Global Equity Returns

Abstract

Interest rate changes typically affect equity values. However, if investors react slowly, the repricing may stretch over time. Using a century of data from sixty countries, we demonstrate that past interest rate changes predict the cross-section of equity returns worldwide. The quintile of stock markets with the highest change in government bond yields under-performs 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 return patterns paves the way for effective country allocation strategies.

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

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