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Monetary Policy Rules and the Equity Premium

Author

Listed:
  • Yulei Peng

    (Lingnan (University) College)

  • Anastasia Zervou

    () (Texas A&M University, Department of Economics)

Abstract

We study the effect of monetary policy on the equity premium using a segmented stock market model. Optimal monetary policy in our model involves risk-sharing and is countercyclical with respect to dividend shocks; thus, it implies low equity return compared to other policies, including inflation targeting. The optimal policy, however, does not guarantee inflation stability and produces higher nominal bond return compared to inflation targeting. Our calibration exercise finds equity premium of 7% under the inflation targeting policy and 1.5% under the optimal policy. We suggest that suboptimal policies focusing on inflation stability might result in high equity premia.

Suggested Citation

  • Yulei Peng & Anastasia Zervou, 2014. "Monetary Policy Rules and the Equity Premium," Working Papers 20141115_001, Texas A&M University, Department of Economics.
  • Handle: RePEc:txm:wpaper:20141115_001
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    Equity premium; Monetary policy; Segmented financial markets;

    JEL classification:

    • 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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