Asset pricing implications of a New Keynesian model

Abstract

We investigate the behavior of asset prices in a typical New Keynesian macro model. Using a second-order approximation, we examine bond and equity returns, the equity risk premium, and the behavior of the real and nominal term structure. As documented in the literature, our results suggest that introducing real rigidities to the model increases risk premia. Nevertheless we that find that, in a world dominated by productivity shocks, increasing nominal rigidities reduces risk premia. Such rigidities only enhance risk premia when economic dynamics are mainly driven by monetary policy shocks. The results imply that, unlike in endowment frameworks, matching asset pricing facts in macro models will require attention to the composition of shocks, not just the specification of investor preferences.

On the Numerical Accuracy of First-Order Approximate Solutions to Dsge Models

“…The habit parameter χ C , η, and the parameters of the capital accumulation equation (21) are taken from Jermann (1998). The parameter ν 1 = 2.5 is from De Paoli et al (2010). Like these authors, we assume that χ N = χ C 12 and choose ν 0 so that at the stationary equilibrium N equals 1/3.…”

Optimal Fiscal and Monetary Policies Under Limited Asset Market Participation

“…When analysing the implications of the availability of fiscal tools for the optimal redistributive policy along the business cycle I consider also a value of σ equal to 5. This value is often used in the macro-finance literature (see De Paoli et al 2010). …”

Monetary and Fiscal Policy in Times of Crises: A New Keynesian Perspective in Continuous Time

“…However, we are focussing on asset market spillovers to the real economy and are thus less interested in analysing financial intermediaries. Brunnermeier and Sannikov (2012) (2010) and Paoli, Scott, and Weeken (2010) and model financial market returns first in discrete time and then switch to continuous time. In the absence of frictions, the model exhibits the well-known equity and term premia puzzle.…”

“…Hence, the price of a zero-coupon bond is given by the first-order conditions (FOCs). We follow Binsbergen et al (2012) and Paoli, Scott, and Weeken (2010) and model the term structure recursively. The one-period nominal bonds deriving the standard relationship are given by…”