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

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Author Info
Romaniuk, Katarzyna () (University of Paris 1 Panthéon-Sorbonne, PRISM)
Vranceanu, Radu () (ESSEC Business School)

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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.

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Publisher Info
Paper provided by ESSEC Research Center, ESSEC Business School in its series ESSEC Working Papers with number DR 08006.

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Length: 16 pages
Date of creation: Mar 2008
Date of revision:
Handle: RePEc:ebg:essewp:dr-08006

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Postal: ESSEC Research Center, BP 105, 95021 Cergy, France
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Related research
Keywords: Optimal Interest Rate Rule; Portfolio Choice; Fed; Asset Prices; Options Theory;

Find related papers by JEL classification:
C61 - Mathematical and Quantitative Methods - - Mathematical Methods and Programming - - - 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

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References listed on IDEAS
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  1. 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. [Downloadable!] (restricted)
  2. James B. Bullard & Eric Schaling, 2002. "Why the Fed should ignore the stock market," Review, Federal Reserve Bank of St. Louis, issue Mar., pages 35-42. [Downloadable!]
  3. 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. [Downloadable!] (restricted)
  4. Glenn D. Rudebusch & Lars E. O. Svensson, 1998. "Policy rules for inflation targeting," Proceedings, Federal Reserve Bank of San Francisco, issue Mar.
    Other versions:
  5. 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, vol. 32(2), pages 113-128, December. [Downloadable!] (restricted)
  6. Marcus H. Miller & Paul Weller & Lei Zhang, 2002. "Moral Hazard and the US Stockmarket: Analyzing the "Greenspan Put"," Peterson Institute Working Paper Series WP02-1, Peterson Institute for International Economics. [Downloadable!]
    Other versions:
  7. Benjamin M. Friedman, 2006. "The Greenspan Era: Discretion, Rather Than Rules," NBER Working Papers 12118, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  8. Svensson, Lars E. O., 1997. "Inflation forecast targeting: Implementing and monitoring inflation targets," European Economic Review, Elsevier, vol. 41(6), pages 1111-1146, June. [Downloadable!] (restricted)
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  9. 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 637-54, May-June. [Downloadable!] (restricted)
  10. Benjamin M. Friedman, 2006. "The Greenspan Era: Discretion, Rather than Rules," American Economic Review, American Economic Association, vol. 96(2), pages 174-177, May. [Downloadable!]
  11. 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. [Downloadable!] (restricted)
    Other versions:
  12. Ben Bernanke & Mark Gertler, 1999. "Monetary policy and asset price volatility," Proceedings, Federal Reserve Bank of Kansas City, pages 77-128. [Downloadable!]
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  13. 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. [Downloadable!] (restricted)
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