Monetary policy and the cyclicality of risk |
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| Institution: | 1. Harvard University, USA;2. Bank of International Settlements, Switzerland;3. INSEAD, France;1. New York University, 40 Washington Square South, New York, NY 10012, United States;2. Board of Governors of the Federal Reserve System, 20th Street and Constitution Avenue N.W., Washington, D.C. 20551, United States;1. Sao Paulo School of Economics-FGV, Brazil;2. Michigan State University, United States;1. London Business School, Regent׳s Park, London NW1 4SA, United Kingdom;2. Department of Economics, University of Leicester, Leicester LE1 7RH, United Kingdom |
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| Abstract: | A dynamic general equilibrium model to study the relationship between monetary policy and movements in risk is developed. Variation in risk arises because households face fixed costs of transferring cash across financial accounts, implying that some households rebalance their portfolios infrequently. Accordingly, prices for risky assets respond sharply to aggregate shocks because only a relatively small subset of consumers are available to absorb these shocks. The model can account for both the mean and the volatility of returns on equity and the risk-free rate and generates a decline in the equity premium following an unanticipated easing of monetary policy. |
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| Keywords: | Segmented markets Equity premium Monetary policy rules |
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