IDEAS home Printed from https://ideas.repec.org/p/ebg/essewp/dr-08006.html
   My bibliography  Save this paper

Asset Prices and Assymetries in the Fed's Interest Rate Rule : a Financial Approach

Author

Listed:

Abstract

Financial Newspapers have for long suggested that the Fed tends to provide additional Liquidity when the Stock Market thumbs. We provide a theoretical Explanation for this Behaviour that builds on the Methodology developed by Romaniuk (2008) for a central Banker with two main Goals, Output and Price stability. In this Paper, the Policymaker behaves as a Portfolio Manager who aims at stabilizing Output, Goods Prices, as well as Asset Prices. An optimal, Time-varying Interest Rate Rule is obtained as the Merton's (1971) continuous Time Solution to the Portfolio Manager's Problem. In a second Step, we infer the optimal Interest Rate Rule of a central Bank that can react differently to positive and negative Variations in the Stock Market.

Suggested Citation

  • Romaniuk, Katarzyna & Vranceanu, Radu, 2008. "Asset Prices and Assymetries in the Fed's Interest Rate Rule : a Financial Approach," ESSEC Working Papers DR 08006, ESSEC Research Center, ESSEC Business School.
    • Handle: RePEc:ebg:essewp:dr-08006
    as

    Download full text from publisher

    File URL: http://www.essec.fr/faculty/showDeclFileRes.do?declId=7691&key=__workpaper__
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. James B. Bullard & Eric Schaling, 2002. "Why the Fed should ignore the stock market," Review, Federal Reserve Bank of St. Louis, vol. 84(Mar.), pages 35-42.
    2. Lioui, Abraham & Poncet, Patrice, 2003. "Dynamic asset pricing with non-redundant forwards," Journal of Economic Dynamics and Control, Elsevier, vol. 27(7), pages 1163-1180, May.
    3. Svensson, Lars E. O., 1997. "Inflation forecast targeting: Implementing and monitoring inflation targets," European Economic Review, Elsevier, vol. 41(6), pages 1111-1146, June.
    4. Marcus Miller & Paul Weller & Lei Zhang, 2002. "Moral Hazard and the US Stock Market: Analysing the "Greenspan Put"," Economic Journal, Royal Economic Society, vol. 112(478), pages 171-186, March.
    5. Glenn Rudebusch & Lars E.O. Svensson, 1999. "Policy Rules for Inflation Targeting," NBER Chapters, in: Monetary Policy Rules, pages 203-262, National Bureau of Economic Research, Inc.
    6. Athanasios Orphanides, 2006. "The Road to Price Stability," American Economic Review, American Economic Association, vol. 96(2), pages 178-181, May.
    7. Merton, Robert C., 1971. "Optimum consumption and portfolio rules in a continuous-time model," Journal of Economic Theory, Elsevier, vol. 3(4), pages 373-413, December.
    8. Allan H. Meltzer, 2006. "From Inflation to More Inflation, Disinflation, and Low Inflation," American Economic Review, American Economic Association, vol. 96(2), pages 185-188, May.
    9. Benjamin M. Friedman, 2006. "The Greenspan Era: Discretion, Rather Than Rules," NBER Working Papers 12118, National Bureau of Economic Research, Inc.
    10. Sauer, Stephan, 2007. "Liquidity Risk and Monetary Policy," Discussion Papers in Economics 2012, University of Munich, Department of Economics.
    11. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    12. Romaniuk, Katarzyna, 2008. "A new approach for modelling and understanding optimal monetary policy," Economics Letters, Elsevier, vol. 100(1), pages 13-15, July.
    13. Katarzyna Romaniuk, 2007. "The optimal asset allocation of the main types of pension funds: a unified framework," The Geneva Papers on Risk and Insurance Theory, Springer;International Association for the Study of Insurance Economics (The Geneva Association), vol. 32(2), pages 113-128, December.
    14. Ben S. Bernanke & Mark Gertler, 1999. "Monetary policy and asset price volatility," Economic Review, Federal Reserve Bank of Kansas City, vol. 84(Q IV), pages 17-51.
    15. Illing, Gerhard, . "Financial Fragility, Bubbles and Monetary Policy," Chapters in Economics,, University of Munich, Department of Economics.
    16. Benjamin M. Friedman, 2006. "The Greenspan Era: Discretion, Rather than Rules," American Economic Review, American Economic Association, vol. 96(2), pages 174-177, May.
    17. Dolado, Juan J. & Maria-Dolores, Ramon & Naveira, Manuel, 2005. "Are monetary-policy reaction functions asymmetric?: The role of nonlinearity in the Phillips curve," European Economic Review, Elsevier, vol. 49(2), pages 485-503, February.
    18. Romaniuk, Katarzyna, 2006. "What if the Fed increased the weight of the stock price gap in its reaction function?," Journal of Policy Modeling, Elsevier, vol. 28(7), pages 725-737, October.
    19. Katarzyna Romaniuk, 2007. "The optimal asset allocation of the main types of pension funds: a unified framework," The Geneva Risk and Insurance Review, Palgrave Macmillan;International Association for the Study of Insurance Economics (The Geneva Association), vol. 32(2), pages 113-128, December.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Vítor Castro, 2008. "Are Central Banks following a linear or nonlinear (augmented) Taylor rule?," NIPE Working Papers 19/2008, NIPE - Universidade do Minho.
    2. Luís, Pacheco, 2004. "Asset Prices and Monetary Policy in the Euro Area: a tentative model," MPRA Paper 6579, University Library of Munich, Germany.
    3. Akosah, Nana Kwame & Alagidede, Imhotep Paul & Schaling, Eric, 2020. "Testing for asymmetry in monetary policy rule for small-open developing economies: Multiscale Bayesian quantile evidence from Ghana," The Journal of Economic Asymmetries, Elsevier, vol. 22(C).
    4. Katarzyna Romaniuk, 2007. "The optimal asset allocation of the main types of pension funds: a unified framework," The Geneva Papers on Risk and Insurance Theory, Springer;International Association for the Study of Insurance Economics (The Geneva Association), vol. 32(2), pages 113-128, December.
    5. Caglayan, Mustafa & Jehan, Zainab & Mouratidis, Kostas, 2012. "Asymmetric monetary policy rules for open economies: Evidence from four countries," MPRA Paper 37401, University Library of Munich, Germany.
    6. Nisticò, Salvatore, 2012. "Monetary policy and stock-price dynamics in a DSGE framework," Journal of Macroeconomics, Elsevier, vol. 34(1), pages 126-146.
    7. Aleksandra Halka, 2015. "Lessons from the crisis.Did central banks do their homework?," NBP Working Papers 224, Narodowy Bank Polski.
    8. Mustafa Caglayan & Zainab Jehan & Kostas Mouratidis, 2016. "Asymmetric Monetary Policy Rules for an Open Economy: Evidence from Canada and the Uk," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 21(3), pages 279-293, July.
    9. Travaglini, Guido, 2007. "The U.S. Dynamic Taylor Rule With Multiple Breaks, 1984-2001," MPRA Paper 3419, University Library of Munich, Germany, revised 15 Jun 2007.
    10. Bjørnland, Hilde C. & Leitemo, Kai, 2009. "Identifying the interdependence between US monetary policy and the stock market," Journal of Monetary Economics, Elsevier, vol. 56(2), pages 275-282, March.
    11. Hinterlang, Natascha & Tänzer, Alina, 2021. "Optimal monetary policy using reinforcement learning," Discussion Papers 51/2021, Deutsche Bundesbank.
    12. Katarzyna Romaniuk, 2020. "Does surplus/deficit sharing increase risk-taking in a corporate defined benefit pension plan?," Decisions in Economics and Finance, Springer;Associazione per la Matematica, vol. 43(1), pages 229-249, June.
    13. Vítor, Castro, 2011. "Can central banks' monetary policy be described by a linear (augmented) Taylor rule or by a nonlinear rule?," Journal of Financial Stability, Elsevier, vol. 7(4), pages 228-246, December.
    14. Svensson, Lars E.O., 2010. "Inflation Targeting," Handbook of Monetary Economics, in: Benjamin M. Friedman & Michael Woodford (ed.), Handbook of Monetary Economics, edition 1, volume 3, chapter 22, pages 1237-1302, Elsevier.
    15. Narek Ohanyan & Aleksandr Grigoryan, 2021. "Measuring monetary policy: rules versus discretion," Empirical Economics, Springer, vol. 61(1), pages 35-60, July.
    16. P Arestis & A Mihailov, 2009. "Flexible Rules cum Constrained Discretion: A New Consensus in Monetary Policy," Economic Issues Journal Articles, Economic Issues, vol. 14(2), pages 27-54, September.
    17. Marco Gross & Willi Semmler, 2019. "Mind the Output Gap: The Disconnect of Growth and Inflation during Recessions and Convex Phillips Curves in the Euro Area," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 81(4), pages 817-848, August.
    18. Ruthira Naraidoo & Leroi Raputsoane, 2015. "Financial markets and the response of monetary policy to uncertainty in South Africa," Empirical Economics, Springer, vol. 49(1), pages 255-278, August.
    19. John B. Taylor, 1999. "Commentary : challenges for monetary policy : new and old," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 59-67.
    20. Grégory Levieuge, 2005. "Politique monétaire et prix d'actifs," Revue de l'OFCE, Presses de Sciences-Po, vol. 93(2), pages 317-355.

    More about this item

    Keywords

    Optimal Interest Rate Rule; Portfolio Choice; Fed; Asset Prices; Options Theory;
    All these keywords.

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:ebg:essewp:dr-08006. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Sophie Magnanou (email available below). General contact details of provider: https://edirc.repec.org/data/essecfr.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.