Dissertation, Otto-Friedrich-Universität Bamberg, 2025

Motivated by the rising trend in public debt and its growing relevance for fiscal and financial policies across advanced and emerging economies, this research examines the impact of the interest rate–growth rate differential (r-g) and the debt-to-GDP ratio on equity market performance. While public debt has become a pressing policy concern, previous research has primarily focused on the debt-to-GDP ratio, often neglecting the evolving significance of the r-g. This research addresses this gap by analysing the short- and long-term effects of both public debt and r-g on equity market performance.

The findings show that rising public debt negatively affects equity market returns in the short term but has positive and statistically significant effects in the long term. Concurrently, rising interest rate–growth rate differential (r-g) exerts a negative influence on both excess and real returns on equity across short- and long-term horizons. Results from both standard linear panel models and panel ARDL models indicate that the relationship between public debt and equity returns is country- and time-specific. Moreover, the findings suggest that the effects of debtto-GDP ratio and r-g on equity market returns cannot be fully explained by important macroeconomic variables such as economic growth, inflation, interest rates, and exchange rates. Finally, contrary to the Ricardian equivalence hypothesis, the short-run effects of public debt align with the debt overhang hypothesis, while the positive long-run effects are consistent with Keynesian economic theory.

The policy implications are twofold. First, public investment should rise to stimulate economic growth, which in turn supports financial markets. Second, analysing the impact of the debt-toGDP ratio in isolation provides only a partial view of the implications of public debt for an economy and financial markets. Instead, the analysis should also incorporate the interest rate–growth rate differential (r-g), as public debt remains sustainable and potentially beneficial so long as economic growth (g) exceeds the cost of debt (r).