Does the BEER Predict the Indian Stock Market?

Abstract

This article critically analyses the time series relationship between bonds and stock yield for the valuation of the National Stock Exchange (NSE) of India. The relationship is known by different names, namely Federal Reserve Bank (Fed) model, bond equity earnings ratio (BEER) and gilt–equity yield ratio (GEYR) model. BEER gives the idea to the investors about stock market valuation. It supports the investor in designing a buying and selling strategy for securities. This study employs Johansen’s cointegration test, Granger causality and variance decomposition tests to check the long and short-run association. The results show that the model can predict short-run returns but is ineffective in the long run. Empirical results also show a bi-directional Granger causality relationship between the BEER and the Nifty 50 index. Our results also indicate that the Indian stock market is overpriced. JEL Codes: G11, G15, G17, G40, G41