correlation betweenP/E ratios,interest rates,and dividend
yields.
Across thesample, P/E ratiosarehigher in countrieswith
lower interest rates—both short-term and long-term. In
addition,P/Eratiostendtobehigherincountrieswithmore
upward-sloping yield curves (measured by the difference
betweenshort-termandlong-termrates),reflectingtheirrole
as proxies for future growth.
There isa mix ofdeveloped market and emerging market
countriesinoursample,andtheP/Eratiostendtobelower
for the latter. To provide at least partial control for this
difference, we introduce a dummy variable set to 1 for
emerging markets and 0 for developed markets. A
cross-sectional regression of P/E ratio on the long-term
interest rate, the slope of the yield curve (the difference
betweenthelong-termandshort-termrate),andtheemerging
market dummy (EMDUM) variable yields the following:
TheR-squaredoftheregressionis24.7%,andthecoefficients
indicatestatisticalsignificance.Otherthingsremainingequal,
this regression suggeststhat a 1% difference in long-term
ratestranslatesintoadifferenceof0.68intheP/Eratioand
that emerging markets trade at lower P/E ratios than