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Model misspecification, the equilibrium natural interest rate and the equity premium

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  • Tristani, Oreste

Abstract

This paper analyses the determinants of the natural rate of interest in a non-linear model where agents are uncertain over both future technology growth and the future course of monetary policy. I show that the real natural rate can be affected by sizable uncertainty premia, including premia associated with monetary un-certainty. 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. JEL Classification: E43, G11

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Paper provided by European Central Bank in its series Working Paper Series with number 0808.

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Date of creation: Sep 2007
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Handle: RePEc:ecb:ecbwps:20070808

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Keywords: equity premium puzzle; model misspecification; Natural rate of interest; risk-free rate puzzle; robust control;

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  1. Athanasios Orphanides & John C. Williams, 2002. "Robust monetary policy rules with unknown natural rates," Working Paper Series 2003-01, Federal Reserve Bank of San Francisco.
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  17. Buraschi, Andrea & Jiltsov, Alexei, 2005. "Inflation risk premia and the expectations hypothesis," Journal of Financial Economics, Elsevier, vol. 75(2), pages 429-490, February.
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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.
  2. Olmos, Lorena & Sanso Frago, Marcos, 2014. "Natural Rate of Interest with Endogenous Growth, Financial Frictions and Trend Inflation," MPRA Paper 57212, University Library of Munich, Germany.

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