Abstract
This study uses a standard equity price equation derived from arbitrage between short-term bonds and shares to explain the conditions under which the relationship between equity prices and the measures of economic activity could yield a Bad News Case or a Good News Case while controlling for the effect of the real exchange rate. We estimate the baseline model and its variants for 18 countries. The results reveal that the good news case dominates the data in advanced and emerging market economies. We find no evidence in support of the bad news case. Furthermore, the real equity price declines with a real appreciation in some countries while it rises with a real appreciation in others.
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