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Asset pricing implications of a New Keynesian model

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  • Bianca De Paoli
  • Alasdair Scott
  • Olaf Weeken

Abstract

To match the stylised facts of goods and labour markets, the canonical New Keynesian model augments the optimising neoclassical growth model with nominal and real rigidities. We ask what the implications of this type of model are for asset prices. Using a second-order approximation, we examine bond and equity returns, the equity risk premium, and the behaviour of the real and nominal term structure. We catalogue the factors that are most important for determining the size of risk premia and the slope and level of the yield curve. In a world of technology shocks only, increasing the degree of real rigidities raises risk premia and increasing nominal rigidities reduces risk premia. In a world of monetary policy shocks only, both real and nominal rigidities raise risk premia. The results indicate that the implications of the New Keynesian model for average asset returns depend critically on the characterisation of shocks hitting the model economy.

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Paper provided by Bank of England in its series Bank of England working papers with number 326.

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Date of creation: Jun 2007
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Handle: RePEc:boe:boeewp:326

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Citations

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Cited by:
  1. Bianca De Paoli, Alasdair Scott, Olaf Weeken, 2007. "Asset pricing implications for a New Keynesian model," Money Macro and Finance (MMF) Research Group Conference 2006 156, Money Macro and Finance Research Group.
  2. Martin M. Andreasen, 2010. "How Non-Gaussian Shocks Affect Risk Premia in Non-Linear DSGE Models," CREATES Research Papers 2010-63, School of Economics and Management, University of Aarhus.
  3. Burkhard Heer & Alfred Maussner, 2011. "Asset Returns, the Business Cycle, and the Labor Market: A Sensitivity Analysis for the German Economy," CESifo Working Paper Series 3391, CESifo Group Munich.
  4. van Binsbergen, Jules H. & Fernández-Villaverde, Jesús & Koijen, Ralph S.J. & Rubio-Ramírez, Juan, 2012. "The term structure of interest rates in a DSGE model with recursive preferences," Journal of Monetary Economics, Elsevier, vol. 59(7), pages 634-648.
  5. Andreasen , Martin & Zabczyk, Pawel, 2011. "An efficient method of computing higher-order bond price perturbation approximations," Bank of England working papers 416, Bank of England.
  6. Burkhard Heer & Torben Klarl & Alfred Maussner, 2012. "Asset Pricing Implications of a New Keynesian Model: A Note," CESifo Working Paper Series 4041, CESifo Group Munich.
  7. Martin Andreasen, 2012. "On the Effects of Rare Disasters and Uncertainty Shocks for Risk Premia in Non-Linear DSGE Models," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 15(3), pages 295-316, July.
  8. Challe, E. & Giannitsarou, C., 2011. "Stock Prices and Monetary Policy Shocks: A General Equilibrium Approach," Working papers 330, Banque de France.
  9. Hatcher, Michael, 2013. "The Inflation Risk Premium on Government Debt in an Overlapping Generations Model," SIRE Discussion Papers 2013-81, Scottish Institute for Research in Economics (SIRE).
  10. De Paoli, Bianca & Zabczyk, Pawel, 2009. "Why do risk premia vary over time? A theoretical investigation under habit formation," Bank of England working papers 361, Bank of England.

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