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Model Misspecification, the Equilibrium Natural Interest Rate, and the Equity Premium

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  • ORESTE TRISTANI

Abstract

This paper analyzes the natural rate of interest and the equity premium in a nonlinear model where agents are uncertain over both future technology growth and the future course of monetary policy. I show that model uncertainty, and notably uncertainty on the future course of monetary policy, can give rise to a sizable precautionary savings motive. This result is potentially problematic for both the estimation of the natural rate and its use as a policy indicator. Monetary uncertainty can also contribute to amplify the equity premium, and to account for its apparent, positive link with inflation. Copyright (c) 2009 The Ohio State University.

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Article provided by Blackwell Publishing in its journal Journal of Money, Credit and Banking.

Volume (Year): 41 (2009)
Issue (Month): 7 (October)
Pages: 1453-1479

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Handle: RePEc:mcb:jmoncb:v:41:y:2009:i:7:p:1453-1479

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Web page: http://www.blackwellpublishing.com/journal.asp?ref=0022-2879

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  13. Olivier J. Blanchard, 1993. "Movements in the Equity Premium," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 24(2), pages 75-138.
  14. Marc P. Giannoni, 2007. "Robust optimal monetary policy in a forward-looking model with parameter and shock uncertainty," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 22(1), pages 179-213.
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  18. Stephen G. Cecchetti & Pok-sang Lam & Nelson C. Mark, 1998. "Asset Pricing with Distorted Beliefs: Are Equity Returns Too Good To Be True?," NBER Working Papers 6354, National Bureau of Economic Research, Inc.
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Cited by:
  1. Lioui, Abraham & Poncet, Patrice, 2012. "On model ambiguity and money neutrality," Journal of Macroeconomics, Elsevier, vol. 34(4), pages 1020-1033.

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