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Monetary Policy Drivers of Bond and Equity Risks

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  • John Y. Campbell

    ()
    (Harvard University)

  • Carolin Pflueger

    ()
    (University of British Columbia)

  • Luis M. Viceira

    ()
    (Harvard Business School, Finance Unit)

Abstract

The exposure of US Treasury bonds to the stock market has moved considerably over time. While it was slightly positive on average in the period 1960-2011, it was unusually high in the 1980s and negative in the 2000s, a period during which Treasury bonds enabled investors to hedge macroeconomic risks. This paper explores the effects of monetary policy parameters and macroeconomic shocks on nominal bond risks, using a New Keynesian model with habit formation and discrete regime shifts in 1979 and 1997. The increase in bond risks after 1979 is attributed primarily to a shift in monetary policy towards a more anti-inflationary stance, while the more recent decrease in bond risks after 1997 is attributed primarily to an increase in the persistence of monetary policy interacting with continued shocks to the central bank's inflation target. Endogenous responses of bond risk premia amplify these effects of monetary policy on bond risks.

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Bibliographic Info

Paper provided by Harvard Business School in its series Harvard Business School Working Papers with number 14-031.

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Length: 69 pages
Date of creation: Sep 2013
Date of revision: Mar 2014
Handle: RePEc:hbs:wpaper:14-031

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Cited by:
  1. Carolin E. Pflueger & Luis M. Viceira, 2011. "Return Predictability in the Treasury Market: Real Rates, Inflation, and Liquidity," NBER Working Papers 16892, National Bureau of Economic Research, Inc.

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