A New Keynesian Model of the Term Structures of Equity and Bond Returns

Pierlauro Lopez, Francisco Vázquez-Grande and David López-Salido
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Francisco Vázquez-Grande: Federal Reserve Board
David López-Salido: Banco de España

No 2635, Working Papers from Banco de España

Abstract: A simple production economy with nominal price rigidities explains several key asset pricing facts, including the average slopes and cyclicality of equity and interest rate term structures. Nominal rigidities amplify the procyclicality of dividends after negative productivity shocks and generate countercyclical inflation, as sluggish price adjustment leads to a gradual dividend recovery. Consequently, short-duration equities (bonds) have more (less) procyclical payoffs than their long-duration counterparts. Slow-moving consumption habits produce large, countercyclical risk prices, yielding realistic asset valuations. Extending Campbell-Cochrane preferences with both market and home consumption habits allows them to operate in production economies while preserving realistic macroeconomic dynamics.

Keywords: equity and bond yields; Campbell-Cochrane habits; nominal rigidities; macrofinance separation; new Keynesian model (search for similar items in EconPapers)
JEL-codes: E43 E44 G12 (search for similar items in EconPapers)
Pages: 53 pages
Date: 2026-10
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Journal Article: A New Keynesian model of the term structures of equity and bond returns (2026)
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Persistent link: https://EconPapers.repec.org/RePEc:bde:wpaper:2635e

DOI: 10.53479/44565

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