On the Economic Link between Asset Prices and Real Activity

Abstract

This paper presents a model linking two financial markets (stocks and bonds) with the real business cycle, in the framework of a CCAPM with GIP preferences. Besides the interest rate term spread, the model includes a new variable to forecast economic activity: the stock market term spread. This is the slope of expected stock market returns. The empirical evidence documented in this paper suggests systematic relationships between the state of the business cycle and the shapes of two yield curves (interest rates and expected stock returns).

Keywords: Stock market, Interest rates, Economic growth

JEL Classification: G12, E44