Identifying the bottom line after a stock market crash

TL;DR

This empirical study demonstrates a consistent negative correlation between stock prices and interest rate spreads after major crashes, highlighting the spread as a measure of economic uncertainty over a long historical period.

Contribution

It reveals a persistent relationship between stock prices and interest rate spreads post-crash, useful for modeling market recovery and uncertainty.

Findings

Strong negative correlation between stock prices and interest rate spreads

Relationship holds across 8 major US stock market crashes from 1857 to 1987

Interest rate spread as a measure of economic uncertainty

Abstract

In this empirical paper we show that in the months following a crash there is a distinct connection between the fall of stock prices and the increase in the range of interest rates for a sample of bonds. This variable, which is often referred to as the interest rate spread variable, can be considered as a statistical measure for the disparity in lenders' opinions about the future; in other words, it provides an operational definition of the uncertainty faced by economic agents. The observation that there is a strong negative correlation between stock prices and the spread variable relies on the examination of 8 major crashes in the United States between 1857 and 1987. That relationship which has remained valid for one and a half century in spite of important changes in the organization of financial markets can be of interest in the perspective of Monte Carlo simulations of stock markets.