What do Interest Rates Reveal about the Stock Market? A Noisy Rational Expectations Model of Stock and Bond Markets

Matthijs Breugem, Adrian Buss and Joel Peress

No 15766, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: We provide novel insights into how investors use information contained in interest rates to learn about economic fundamentals and how this affects informational and allocative efficiency. Specifically, we develop a noisy rational expectations equilibrium model with an endogenous interest rate that investors use to update their beliefs. The model yields two key findings. First, the interest rate reveals primarily information about discount rates, allowing investors to extract more information about cashflows from stock prices. Second, the precision of the interest-rate signal and, hence, stock-price informativeness are positively correlated with the interest rate. We present evidence consistent with this prediction.

Keywords: (endogenous); interest; rates (search for similar items in EconPapers)
JEL-codes: E43 E44 G11 G14 (search for similar items in EconPapers)
Date: 2021-02
New Economics Papers: this item is included in nep-cba, nep-cwa and nep-mac
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