Stock prices and monetary policy shocks: A general equilibrium approach |
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Institution: | 1. Banco de España-Eurosystem, Spain;2. University of Nottingham, United Kingdom;1. Research Department, Federal Reserve Bank of Atlanta, 1000 Peachtree Street NE, Atlanta, GA 30309-4470, USA;2. Department of Finance, Accounting and Managerial Economics, Olayan School of Business, American University of Beirut, P.O. Box 11-0236, Riad El-Solh Street, Beirut 1107 2020, Lebanon |
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Abstract: | Empirical literature documents that unexpected changes in the nominal interest rates have a significant effect on real stock prices: a 100-basis point increase in the nominal interest rate is associated with an immediate decrease in broad real stock indices that may range from 2.2 to 9%, followed by a gradual decay as real stock prices revert towards their long-run expected value. We assess the ability of a general equilibrium New Keynesian asset-pricing model to account for these facts. We consider a production economy with elastic labor supply, staggered price and wage setting, as well as time-varying risk aversion through habit formation. We find that the model predicts a stock market response to policy shocks that matches empirical estimates, both qualitatively and quantitatively. Our findings are robust to a range of variations and parametrizations of the model. |
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Keywords: | Monetary policy Asset prices New Keynesian general equilibrium model |
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