Canadian Stock Returns and the Term Structure of Interest Rates

Abstract

This study examines the relationship between stock returns and the term structure of interest rates in a Canadian setting. Following Zhou’s study of the U.S. market (Federal Reserve Board, 1996), the hypothesis tested is the excess return hypothesis, which states that expected returns move one-for-one with ex-ante interest rates. Inasmuch as the co-movement of nominal stock returns and nominal interest rates could be due to changes in expected inflation, the hypothesis is tested using real as well as nominal return data. The study examines the ability of both U.S. and Canadian interest rates to predict Canadian stock returns. Stock returns were computed using the S&P/TSX monthly price index of stocks traded on the Toronto Stock Exchange. The monthly price index data cover the period 1956:01 to 2008:06. Log returns were computed for horizons of 3, 12, 24, 36, 60 and 84 months and then annualized for each month. The zero-coupon bond yield for the matching maturity implied by the term structure for Canadian government securities is used as a proxy for the Canadian interest rate. The Canadian term structure data (obtained from the Bank of Canada) are only available from 1986:01, with the exception of the 3-month maturity yield, which is available from 1956:01 from the Canadian Socio-Economic Management (CANSIM) database. U.S. zero-coupon bond yields were available for the entire period for all investment horizons considered. Data for the period 1956:01 to 1991:02 were obtained from McCulloch and Kwon’s (1993) dataset of zero-coupon bond yields implied by the yield curve of U.S. Treasury securities. Data for the period 1991:03 to 2009:01 were obtained from the Center for Research in Security Prices (CRSP) database. Int Adv Econ Res (2014) 20:465–466 DOI 10.1007/s11294-014-9491-y