Stock Market Price-to-Earnings Ratio and Credit Spread : Dynamic Response and Causality

This study examines the dynamic response of the S&P 500 price-to-earnings ratio (PE) to credit spread (CS) shock and causal direction between these two variables. Based on the analysis of monthly data from 1919M1 to 2013M8, the VAR results reveal that PE significantly jumps immediately following the shock to CS. The results obtained from Granger causality Wald tests also confirm a significant causal linkage between PE and CS. The variance decomposition results show that PE forecasts about 7.41%, and 12.43% at the 6-month and 12-month horizons respectively