 Inflation and the stock market: Understanding the "Fed Model"Geert Bekaert and Eric Engstrom Journal of Monetary Economics, 2010, vol. 57, issue 3, 278-294 Abstract: The so-called Fed model postulates that the dividend or earnings yield on stocks should equal the yield on nominal Treasury bonds, or at least that the two should be highly correlated. In US data there is indeed a strikingly high time series correlation between the yield on nominal bonds and the dividend yield on equities. This positive correlation is often attributed to the fact that both bond and equity yields comove strongly and positively with expected inflation. Contrary to some of the extant literature, we show that this effect is consistent with modern asset pricing theory incorporating uncertainty about real growth prospects and habit-based risk aversion. In the US, high expected inflation has tended to coincide with periods of heightened uncertainty about real economic growth and unusually high risk aversion, both of which rationally raise equity yields. Keywords: Money; illusion; Equity; premium; Countercyclical; risk; aversion; Fed; model; Inflation; Economic; uncertainty; Dividend; yield; Stock-bond; correlation; Bond; yield (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:moneco:v:57:y:2010:i:3:p:278-294 Access Statistics for this article Journal of Monetary Economics is currently edited by R. G. King and C. I. Plosser More articles in Journal of Monetary Economics from Elsevier |
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