Government Debt Expansion and Stock Returns

Using an international dataset, this paper documents a negative association between increases in the central government debt-to-GDP ratio and dollar-denominated stock index returns. Depending on the estimation method, raising the debt ratio by one percentage point diminishes the stock returns by between 39 to 95 basis points. We show that this result cannot be explained by changes in the investment risk. Instead, government debt issuance exerts upward pressure on private interest rates and appears to signal a greater tax burden in the future. These two factors coincide to produce a fall in stock market prices