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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

How do monetary policy rules, monetary policy uncertainty, and macroeconomic shocks affect the risk properties of US Treasury bonds? The exposure of US Treasury bonds to the stock market has moved considerably over time. While it was slightly positive on average over 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 develops a New Keynesian macroeconomic model with habit formation preferences that prices both bonds and stocks. The model attributes the increase in bond risks in the 1980s to a shift towards strongly anti-inflationary monetary policy, while the decrease in bond risks after 2000 is attributed to a renewed focus on output fluctuations, and a shift from transitory to persistent monetary policy shocks. Endogenous responses of bond risk premia amplify these effects of monetary policy on bond risks.

Suggested Citation

  • John Y. Campbell & Carolin Pflueger & Luis M. Viceira, 2013. "Monetary Policy Drivers of Bond and Equity Risks," Harvard Business School Working Papers 14-031, Harvard Business School, revised Jun 2015.
    • Handle: RePEc:hbs:wpaper:14-031
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    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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