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Monetary Policy Drivers of Bond and Equity Risks

  • John Y. Campbell
  • Carolin Pflueger
  • Luis M. Viceira

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 a renewed emphasis on output stabilization and an increase in the persistence of monetary policy. Endogenous responses of bond risk premia amplify these effects of monetary policy on bond risks.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 20070.

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Date of creation: Apr 2014
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Handle: RePEc:nbr:nberwo:20070
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