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Heterogeneous beliefs, monetary policy, and stock price volatility

Katsuhiro Oshima ()
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Katsuhiro Oshima: MetLife Insurance K.K.

Annals of Finance, 2021, vol. 17, issue 1, No 4, 79-125

Abstract: Abstract In this paper, I build a two-agent New Keynesian model in which households with subjective and objective beliefs about capital gains from stock prices exist. The former type of households constructs their beliefs about expected capital gains by Bayesian learning from observed growth rates of stock prices. In a homogenous agent model with only subjective beliefs, the effect of the interest rate on stock prices tends to be unrealistically strong. I show how the presence of heterogeneity improves second moments of stock prices with realistic moments of business cycle properties. This quantitative improvement in stock price behaviors allows me to conduct a realistic analysis of how the stance of monetary policy affects stock price volatilities. Strong inertia of monetary policy provides the stability of stock prices. This is because the near-term real interest rate has dominant effects on stock prices under the presence of subjective beliefs since the presence limits the forward-looking nature in pricing stocks. However, because output depends on the expected path of the real interest rate in the forward-looking manner, strong monetary policy inertia does not necessarily provide stabilities of stock prices and output at the same time.

Keywords: Stock price; Asset pricing; Heterogeneity; Subjective belief; Monetary policy; New Keynesian (search for similar items in EconPapers)
JEL-codes: D83 D84 E44 E52 G12 G14 (search for similar items in EconPapers)
Date: 2021
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DOI: 10.1007/s10436-020-00379-9

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