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Asset pricing implications for a New Keynesian model

  • Bianca De Paoli, Alasdair Scott, Olaf Weeken

    (Bank of England)

To match the stylised facts of goods and labour markets, the canonical New Keynesian model augments the optimising neoclassical growth model with nominal and real rigidities. We ask what the implications of this type of model are for asset prices. Using a second-order numerical solution to the model, we examine bond and equity returns, the equity risk premium, and the behaviour of the real and nominal term structure. We catalogue the factors that are most important for determining the size of risk premia and the slope and level of the yeild curve. In a world of technology shocks only, increasing the degree of real rigidities raises risk premia and increasing nominal rigidities reduces risk premia. In a world of monetary policy shocks only, both real and nominal rigidities raise risk premia. The results indicate that the iimplications of the New Keynesian nodel for average asset returns depend critically on the characterisation of shocks hitting the model economy

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Paper provided by Money Macro and Finance Research Group in its series Money Macro and Finance (MMF) Research Group Conference 2006 with number 156.

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Date of creation: 02 Feb 2007
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Handle: RePEc:mmf:mmfc06:156
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