In this link, we can read "The revised reading of second-quarter gross domestic product growth beat analysts’ expectations triggering a stock-market rally and a bond selloff." Well, why can we assume that the upward pressure on the nominal interest rate won't be enough to decrease the stock values by counteracting the increasing nominal dividends that stocks provide?(i.e. the LM curve is flat)


1 Answer 1


Consider an investor who splits up his portfolio into stocks and bonds according to some ratio that considers all things that need to be considered. These include returns etc. Assume the portfolio is "correct" i.e. in equilibrium. Through the GDP revision, stocks become more attractive compared to bonds for the individual investor, so each individual investor has to adjust his ratios and increase the nr. of stocks, which means he has to sell bonds. The individual investor does not expect his action to actually influence government bond yields as he is small compared to the market. If all investors do this, then we get the result mentioned in the link.

Further dividends are not the only reason stocks have value. Many companies don't pay out dividends, because the shareholders then have to pay tax on them, but rather re-invest the profits which increases the stock value, which can then be sold.

Also its not clear that the government bond interest rate is the relevant interest rate for discounting for these investors (the effect you are referring to).


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