COWLES FOUNDATION FOR RESEARCH IN ECONOMICS
AT YALE UNIVERSITY

Box 208281
New Haven, CT 06520-8281

COWLES FOUNDATION DISCUSSION PAPER NO. 953

"Stock Prices and Bond Yields: Can Their Co-Movements Be Explained
in Terms of Present Value Models?"

Robert J. Shiller and Andrea Beltratti

September 1990

Real stock prices seem to overreact to changes in long-term interest rates. That is, real stock prices drop when long-term interest rates rise (and rise when they fall) more than would be implied by a rational expectations present value model where expectations are based on a vector autoregression. This overreaction is not associated with any overreaction to changes in the short-run inflation rate. Over the last century real stock prices have shown little reaction to changes in inflation rates, and according to the model they should show little reaction. These conclusions were reached from an analysis of annual data in the United States 1871 to 1989 and the United Kingdom 1918 to 1989.