What Moves the Stock and Bond Markets? A Variance Decomposition for Long-Term Asset Returns




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    • Woodrow Wilson School, Princeton University and International Finance Division, Board of Governors of the Federal Reserve System. This paper was presented at the annual meeting of the American Finance Association, Washington DC, December 1990. We are grateful to Ben Bernanke, Robert Stambaugh, and two anonymous referees for helpful comments, and to Rick Mishkin for assistance with the data. Campbell acknowledges financial support from the National Science Foundation and the Sloan Foundation. The opinions expressed in this paper are those of the authors and do not necessarily reflect the views of the Board of Governors or other employees of the Federal Reserve System.


This paper uses a vector autoregressive model to decompose excess stock and 10-year bond returns into changes in expectations of future stock dividends, inflation, short-term real interest rates, and excess stock and bond returns. In monthly postwar U.S. data, stock and bond returns are driven largely by news about future excess stock returns and inflation, respectively. Real interest rates have little impact on returns, although they do affect the short-term nominal interest rate and the slope of the term structure. These findings help to explain the low correlation between excess stock and bond returns.