Stock Market Fluctuations and the Term Structure

This paper uses the term structure of interest rates to explain the variations of stock prices and stock returns. It shows that interest rates have an important impact on stock returns, especially at long horizons. The hypothesis that expected stock returns move one-for-one with ex ante interest rates, which has been rejected in other studies using short horizon nominal asset returns, is supported by evidence from real returns and long horizon nominal returns. The paper nds that long-term interest rates explain a major part of variation in dividend-price ratios and suggests that the high volatility of the stock market is related to the high volatility of long-term bond yields and may be accounted for by changing forecasts of discount rates. The ndings of this paper may provide a reasonable economic explanation for the predictability of long-horizon stock returns.