Monetary Policy Rules and the Equity Premium

Anastasia Zervou

No 1624, 2016 Meeting Papers from Society for Economic Dynamics

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.

Date: 2016
New Economics Papers: this item is included in nep-dge, nep-mac and nep-mon
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed016:1624

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