Government debt expansion and stock returns

Abstract Using an international data set, this article 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 1 percentage point diminishes the stock returns by between 39 and 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.