Stock prices and the risk-free rate: An internal rationality approach
Journal of Economic Dynamics and Control, 2021, vol. 127, issue C
The co-movement of stock prices and the risk-free rate in the United States is weak in terms of the correlation and variance decomposition. It is essential for investors and policymakers to understand such co-movement, especially when several well-known asset pricing models imply a much stronger relationship than the one empirically observed. To explain this inconsistency, this paper presents a model with “internally rational” agents who optimally update their subjective beliefs about stock prices. Compared with the risk-free rate, agents’ subjective beliefs are essential for generating stock market volatility. Quantitatively, our model can jointly produce basic asset market facts and the weak co-movement.
Keywords: Stock prices; Risk-free rate; Internal rationality learning; Correlation; Variance decomposition (search for similar items in EconPapers)
JEL-codes: D84 E44 G12 (search for similar items in EconPapers)
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1) Track citations by RSS feed
Downloads: (external link)
Full text for ScienceDirect subscribers only
This item may be available elsewhere in EconPapers: Search for items with the same title.
Export reference: BibTeX
RIS (EndNote, ProCite, RefMan)
Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:127:y:2021:i:c:s0165188921000385
Access Statistics for this article
Journal of Economic Dynamics and Control is currently edited by J. Bullard, C. Chiarella, H. Dawid, C. H. Hommes, P. Klein and C. Otrok
More articles in Journal of Economic Dynamics and Control from Elsevier
Bibliographic data for series maintained by Catherine Liu ().