The Association between Changes in Interest Rates, Earnings, and Equity Values

41 Pages Posted: 14 Jul 2003

See all articles by Doron Nissim

Doron Nissim

Columbia University - Columbia Business School

Stephen H. Penman

Columbia Business School - Department of Accounting

Date Written: May 2003

Abstract

Numerous studies have documented that stock returns are negatively related to changes in interest rates, but there has been little corroborating research on the information in interest rate changes about the fundamentals which the stock market prices. The negative correlation is often attributed to changes in the discount rate, a denominator effect in a valuation model. However, there may also be a numerator effect on the expected payoffs that are discounted. This paper shows that changes in interest rates are positively related to subsequent earnings, but the change in earnings is typically not large enough to cover the change in the required return. Hence the net (numerator and denominator) effect on equity value is negative, consistent with the results of the research on interest rates and stock returns.

Keywords: interest rates, expected inflation, earnings, equity valuation

JEL Classification: G12, M41, E31, E32

Suggested Citation

Nissim, Doron and Penman, Stephen H., The Association between Changes in Interest Rates, Earnings, and Equity Values (May 2003). Available at SSRN: https://ssrn.com/abstract=417040 or http://dx.doi.org/10.2139/ssrn.417040

Doron Nissim (Contact Author)

Columbia University - Columbia Business School ( email )

3022 Broadway
604 Uris Hall
New York, NY 10027
United States
212-854-4249 (Phone)

Stephen H. Penman

Columbia Business School - Department of Accounting ( email )

3022 Broadway
New York, NY 10027
United States
212-854-9151 (Phone)
212-316-9219 (Fax)

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