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Stock Prices and the Risk-free Rate: An Internal Rationality Approach

SSRN, ISSN: 1556-5068
2020
  • 0
    Citations
  • 701
    Usage
  • 0
    Captures
  • 0
    Mentions
  • 0
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Metric Options:   Counts1 Year3 Year

Metrics Details

  • Usage
    701
    • Abstract Views
      593
    • Downloads
      108
  • Ratings
    • Download Rank
      509,390

Article Description

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.

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