DP8387 Stock Prices and Monetary Policy Shocks: A General Equilibrium Approach
|Author(s):||Edouard Challe, Chryssi Giannitsarou|
|Publication Date:||May 2011|
|Keyword(s):||Asset prices, Monetary policy, New Keynesian general equilibrium model|
|JEL(s):||E31, E52, G12|
|Programme Areas:||International Macroeconomics, Financial Economics|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=8387|
Recent empirical literature documents that unexpected changes in the nominal interest rates have a significant effect on stock prices: a 25-basis point increase in the Fed funds rate is associated with an immediate decrease in broad stock indices that may range from 0.5 to 2.3 percent, followed by a gradual decay as stock prices revert towards their long-run expected value. In this paper, we assess the ability of a general equilibrium New Keynesian asset-pricing model to account for these facts. The model we consider allows for 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 parameterizations of the model.