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Monetary Policy Rules and the Equity Premium

Listed author(s):
  • Yulei Peng

    (Lingnan (University) College)

  • Anastasia Zervou

    ()

    (Texas A&M University, Department of Economics)

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.

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File URL: http://respec.tamu.edu/zervoumonetarypolicyequitypremium.pdf
File Function: First version, 2014
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Paper provided by Texas A&M University, Department of Economics in its series Working Papers with number 20141115_001.

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Length: 48 pages
Date of creation: 15 Nov 2014
Handle: RePEc:txm:wpaper:20141115_001
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