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Stock Prices And Monetary Policy Shocks: A General Equilibrium Approach

  • Edouard Challe

    (Department of Economics, Ecole Polytechnique - CNRS : UMR7176 - Polytechnique - X, Banque de France - -, CREST - Centre de Recherche en Économie et Statistique - INSEE - École Nationale de la Statistique et de l'Administration Économique)

  • Chryssi Giannitsarou

    (University of Cambridge - Faculty of Economics, CEPR - Center for Economic Policy Research - CEPR)

Recent empirical literature documents that unexpected changes in the nominal interest rates have a significant effect on real stock prices: a 25-basis point increase in the nominal interest rate is associated with an immediate decrease in broad real stock indices that may range from 0.6 to 2.2 percent, followed by a gradual decay as real stock prices revert towards their long-run expected value. In this paper, we assess the ability of a general equilibrium New Keynesian asset-pricing model to account for these facts. The model we consider is a production economy with elastic labor supply, staggered price and wage setting, as well as time-varying risk aversion through habit formation. We find that the model predicts a stock market response to policy shocks that matches empirical estimates, both qualitatively and quantitatively. Our findings are robust to a range of variations and parameterizations of the model.

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Date of creation: 23 Jul 2012
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